Inflation figures trigger QE reversal fears

Fears that the Bank of England may have to reverse its policy of quantitative easing – injecting cash directly into the economy – and raise rates sooner than expected were heightened yesterday with the publication of the latest inflation figures.

The Office for National Statistics said that the annual rate of CPI inflation rose sharply higher in the year to October to 1.5 per cent, up from the 1.1 per cent annual rate of change recorded in September.

Higher petrol prices, reflecting a recent revival in world commodity prices, were responsible for much of the jump. Experts say that petrol prices may reach 110p per litre – about £5 a gallon – by the end of the year.

The more familiar RPI, which also reflects radically lower mortgage interest bills, showed that the cost of living fell by 0.8 per cent, compared with a drop of 1.4 per cent in September.

The prospect – distant but slightly closer now – of higher UK rates boosted the attractiveness of sterling to investors: the pound rose by 0.6 per cent to a two-month high against the euro, and advanced against the US dollar.

Although inflation figures were only marginally ahead of analysts' estimates, they add to the short-term nervousness about the UK's volatile inflation outlook. VAT will return to 17.5 per cent on 1 January, and other price pressures are in the pipeline, mainly derived from the 25 per cent depreciation of sterling seen over the last two years and a new commodity price boom. These may add to inflationary expectations and push prices up more generally. The Bank of England admitted in its latest Inflation Report, published last week, that its Monetary Policy Committee would have to "look through" short-term spikes in inflation, which will push to beyond 3 per cent early next year.

Economists disagree on how much "core" inflation there is, that is eliminating volatile items such as food. Service sector inflation has been less strong than goods inflation.

Colin Ellis, UK economist at Daiwa Securities, said: "Earnings growth and services inflation is much less energy and import intensive than goods inflation. Earnings growth remains subdued – and services price inflation hit a new record low. Services prices take longer to adjust to changes in the economy than goods prices, and that strongly suggests that underlying disinflationary pressures are still lurking. As long as medium-term expectations remain anchored, the MPC should keep policy in accommodative mode."

However, the risk is that a series of inflation may make it more and more difficult for the Bank to maintain credibility and ensure that inflationary expectations remain "anchored" in line with the official target of 2 per cent.

Remarks by a senior member of the MPC, Andrew Sentence, stressing the danger that inflation poses to the Bank's policy of radical monetary easing, also helped push sterling higher on hopes of higher rates, or at least no further boost to quantitative easing beyond the £200bn already committed.