Bank's letter to Chancellor reveals fears of inflation rate rising above 4 per cent

Inflation is likely to rise sharply this year to above 4 per cent, the Bank of England has warned. Last month, it rose to 3.3 per cent, from 3 per cent in April. Inflation is at its highest since July 1992, and some way off the Government's target of 2 per cent.

When the rate is more than one percentage point away from the target, the Governor of the Bank is obliged to write a letter of explanation to the Chancellor of the Exchequer.

In his note, Mervyn King told the Chancellor, Alistair Darling, that "in the past month, oil prices have risen by about 15 per cent and wholesale gas futures prices for the coming winter have increased by a similar amount. As things stand, inflation is likely to raise sharply in the second half of the year, to above 4 per cent."

Mr King added: "I must stress that there are considerable uncertainties, in both directions, around this." He explained that almost all of the increase in inflation was accounted for by food, fuel, gas and electricity.

This was only the second letter that the Bank has had to write since it was granted operational independence in 1997. Mr King indicated that inflation was not expected to return to target for two years.

In its latest release, the Office for National Statistics reported that the largest upward pressures came from food and non-alcoholic beverages, where the annual rate of inflation rose from 6.6 per cent to 7.8 per cent. Food inflation rose to 8.7 per cent, with meat and vegetable prices soaring. Electricity and gas prices were up 11.2 per cent. Diesel and petrol prices also rose.

The older retail price index was also up, although by less, reflecting the influence of lower house prices in its composition. The RPI rose to 4.3 per cent in May, up from 4.2 per cent in April. Among widespread scepticism that the inflation figure really reflects what is happening in the economy – polls suggest people believe inflation is actually 4.9 per cent – the present round of price increases will hit poorer pensioners badly. "When older people live on a fixed income it is virtually impossible for them to cope with higher and higher bills," said Mervyn Kohler, the special adviser for Help the Aged. "Between rises in water bills, council tax, food and fuel it is no wonder pensioner poverty itself is on the rise. The Government must act now and take responsibility for the financial hardship that so many older people face."

Despite the gloomy news on inflation, the stock market rose and sterling fell as analysts took the tone of Mr King's letter to mean that he would not, as has been feared, raise interest rates sharply to curb inflation, although the strategy followed so far this year of gradually cutting rates to stave off recession seems to be have been abandoned.Mr King and Mr Darling will make set-piece speeches on the economy at the Mansion House, in the City of London, tonight.

Mary Phillips, 72: 'Fuel bills are the worst'

Ms Phillips, from south London, is one of thousands of pensioners who have felt the cost of living rise much more than the official rate of 3.3 per cent. "The worst has been electricity and gas," she says. "The winter fuel payment hasn't been nearly enough." With her pension credit having risen by just a few pence, Ms Phillips is now much more careful with her cash. According to the Government's personal inflation calculator, her true inflation rate over the past year has been at least 6 per cent.

Dave Woodward, 41: 'We're driving a lot less'

Mr Woodward, a father of four from Essex, says his main expenses have been rising faster than his salary. He has cut back on non-essentials, eating out less, and even cutting the children's pocket money. "We're driving a lot less," he says. "We used to visit my mum, who lives 40 miles away, every couple of weeks, but we go less because it costs so much." According to the Government's personal inflation calculator, Mr Woodward's inflation rate is over 6 per cent.