Inflation reaches its highest level in three years

DIANE COYLE

Economics Correspondent

Inflation last month reached its highest level for nearly three years, while retail sales fell sharply. The hot weather was partly to blame, and the disappointing figures did nothing to mute calls for a cut in base rates.

The British Retail Consortium (BRC) said a lack of consumer confidence meant a cut in interest rates was needed. The Association of British Chambers of Commerce said more shop closures were likely. The Institute of Directors added its voice. ``There is a risk that the economy is not just slowing down but coming to a grinding halt,'' said Ruth Lea, director of its policy unit.

The rise in inflation in August increased City caution about when the Chancellor might decide to cut base rates. Economists said the timing could depend on the Budget on 28 November.

The Governor of the Bank of England is likely to advise keeping rates unchanged unless he knows there will be a cautious Budget, said Paul Mortimer- Lee, chief economist at investment bank Paribas.

Separate figures on US retail sales showed a far weaker than expected rise in August. Sales volumes fell, apart from cars, which were strong, thanks to special incentives. The figures boosted hopes of an interest rate reduction in the US.

August's heatwave sent demand for cold drinks soaring, but made it too hot for consumers to shop for items such as clothing and household goods. Even sales of lottery tickets - not included in the official retail sales statistics - fell, according to the BRC.

The volume of retail sales fell 0.8 per cent in August, to a level little higher than a year earlier. There is anecdotal evidence of some recovery in September; John Lewis reported a recovery in department store sales so far this month.

But City analysts said the figures showed there was little sign of inflationary pressure reaching the high street. ``If it isn't cheap, people won't buy it,'' said Mr Mortimer-Lee.

Analysts on the whole shrugged off the higher-than-expected rise in inflation. The headline rate of retail price inflation rose from 3.5 per cent to 3.6 per cent last month. This was the highest since October 1992. The Government's target measure, the RPI less mortgage interest payments, rose to 2.9 per cent, compared with a target of 2.5 per cent.

The drought was again to blame. There was a record increase in seasonal food prices, which jumped 13.1 per cent in the month. Smaller rises in other items, including motoring costs and personal goods and services, partly offset its impact on the headline inflation rate.

The Treasury said underlying inflation had remained below 3 per cent for nearly two years. Although opinions vary, many economists think inflation will continue to rise for only a few more months. Geoffrey Dicks, chief economist at NatWest Markets, said: ``Underlying inflation is near its peak.'' However, he added that it is likely to rise during the next month or two.