Bank chief warns over inflation

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The Governor of the Bank of England warned today that there was a "great deal of uncertainty" over the outlook for inflation after the rate soared to its highest level in more than two years.

In a letter to Chancellor George Osborne, Mervyn King said inflation was likely to continue to pick up to between 4% and 5% over the next few months and admitted there were "real differences of view" among Bank policymakers.

The Governor's comments came as the Office for National Statistics (ONS) revealed that the Consumer Prices Index (CPI) rate of inflation hit 4% in January, up from 3.7% in December.

The ONS said inflation was being driven up by soaring commodity prices, such as crude oil, as well as the impact of the VAT rise from 17.5% to 20% last month.

The governor is required to write a letter of explanation to the Chancellor when inflation has been 1% or more above the Government's 2% target for three months in a row.

In his letter, Mr King said the high level of inflation was down to the rise in VAT, the low value of the pound and rising energy prices.

He said: "There is a great deal of uncertainty about the medium-term outlook for inflation. And I do not wish to conceal there are real differences of view within the committee, reflecting different judgements about the risks to that outlook.

"Inflation is likely to continue to pick up to somewhere between 4% and 5% over the next few months ahead."

The governor said the MPC believes that pulling inflation back to target quickly could damage economic growth and would increase the risk of undershooting the 2% target.

Mr King said there was a risk that the high cost of living could increase inflation expectations and thereby pull up wages and other prices.

He went on: "Inflation is likely to remain above target for this year, before falling back in 2012."

After holding interest rates at 0.5% and the level of quantitative easing at £200 billion at this month's meeting, Mr King said the MPC was "conscious that there are large risks in both directions".

January's CPI figure, the highest since November 2008, is double the Government's target and is likely to throw weight behind the argument for an interest rate hike.

However, weaker-than-expected growth figures, revealing a 0.5% decline in GDP in the final quarter of 2010, have highlighted the fragile position the economy is in.

The CPI rate of inflation rose by 0.1% on a monthly basis between December and January, the first time since records began in 1997 that prices rose between those two months.

The price of petrol as recorded by the CPI hit 127p per litre in January - a record high, according to the ONS.

But rising prices in transport, restaurant and hotels, furniture and alcohol also made significant contributions to the increase in the overall rate of inflation.

Within transport, prices of new cars were up 2.4% between December and January while second-hand cars went up 2%.

The VAT hike led to a rise in restaurant and hotel bills, which were up 1.3% between December and January, and hit a record 4.5% rise on an annual basis.

There was some downward pressure on inflation from falling clothing prices as well as a drop in the cost of recreational activities, such as DVD and CD purchases.

The City will be looking closely at the Bank's latest quarterly inflation report, which is published tomorrow, for more clues about when an interest rate hike is most likely.

In response to the Governor's letter, the Chancellor pointed out that stepping back from the current programme of austerity measures would put upward pressure on inflation.

He added: "For its part, the Government's commitment to delivering its fiscal consolidation plan continues to provide the MPC with the space it needs to target low inflation."

David Cameron's official spokesman told reporters at a daily media briefing: "Clearly, dealing with inflation and monetary policy are matters which are for the MPC.

"The Prime Minister has been pointing out in recent weeks that there is some difficult work to do on the economy.

"We have to deal with public debt and a record deficit and we have to rebalance our economy so it is is not reliant on one region or one industry.

"We recognise that that process is going to take time."

The spokesman declined to comment on the potential impact of today's figures on interest rates, saying that it was a matter for the MPC.