Mortgage increases push up inflation to two-year high

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The rate of inflation jumped to its highest for two years last month, but increased mortgage rates were the main culprit. The underlying inflation measure, excluding mortgage interest payments, edged closer towards the Government's 2.5 per cent target.

The latest economic figures are unlikely to affect the Bank of England's Monetary Policy Committee, holding its monthly meeting today and tomorrow. It is not expected to raise interest rates, at least for now.

City experts said the retail price figures were a mixed bag. The mortgage increases took the headline rate of inflation to 3.5 per cent in August from 3.3 per cent. As recently as April, before any of the recent interest rate increases, headline inflation was only 2.4 per cent.

On the other hand, the target measure, the RPI less mortgage interest payments, fell from 3 per cent to 2.8 per cent in August. Its target is 2.5 per cent, although the Bank can allow it to vary between 1.5 per cent and 3.5 per cent.

The main reason for the decline in underlying inflation was an unexpected drop in the price of seasonal foods. The price of fresh vegetables like lettuce and tomatoes declined by 10.5 per cent during the month compared with 8.3 per cent last August.

Strawberry prices also fell from their high levels in July as the weather improved, whereas last August they had jumped.

Food prices overall fell by 0.4 per cent in the year to August, with the seasonal component declining 5.1 per cent and non-seasonal food prices edging up by 0.3 per cent during the 12 months.

However, there were price increases in all other categories. The annual rate of price increase in leisure services climbed to 5.8 per cent from 4.9 per cent in July. Higher foreign holiday costs were to blame.

Clothing and footwear prices jumped 2 per cent during the month, a seasonal effect as the new fashions reach the high street.

But the inflation rate for this category jumped to 1.6 per cent from 1.1 per cent the previous month.

Although the figures did not affect prospects for interest rates, City economists were underwhelmed. "The target measure will carry on falling for a bit longer but it will be difficult to sustain inflation around 2.5 per cent," said Eric Fishwick of Nikko Europe.

John O'Sullivan at NatWest Markets agreed. "There is no obvious downward trend towards the target," he said.

Some expressed concern that the jump in the headline rate would put upward pressure on wages because pay negotiations use it, rather than the government's target measure, as their benchmark. Incomes Data Services, which monitors pay settlements, recently reported more increases of 3.5 per cent and over.

"As the Bank has stated explicitly that it regards the danger of rising pay pressures as being one of the key `upside risks' to inflation, the potential consequences of the rise in the headline rate will alarm them," said Richard Iley at ABN-Amro.