Inflation soars as commodity price surge hits the high street

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The Independent Online

Inflation has jumped to a two-year high, ahead of City expectations and adding to pressure on the Bank of England to raise interest rates, as food price inflation rises to levels even higher than those seen in the Great Inflation of the 1970s. Pensioners and savers are being hardest hit.

The Office for National Statistics said that the annual rate of price increases on the consumer price index (CPI) measure stood at 3.7 per cent in December, up from 3.3 per cent in November and against the economists' consensus of around 3.5 per cent. In December alone, prices were up by 1 per cent – the highest monthly rise since this series began in 1996. At 122p per litre on the ONS's readings, the price of petrol stands at an all-time high, exceeding the peaks in 2008. Also reflecting the trend in global commodity prices, heating oil was up 48.7 per cent on the year.

On the older retail price index, which includes an element of house price inflation, the cost of living is up 4.8 per cent on a year ago, compared with 4.7 per cent in the 12 months to November. As the measure most often used in pay bargaining, the rise in RPI will worry policymakers concerned that imported and one-off inflation caused by hikes in VAT might trigger a "home-grown" wage-price spiral. CPI is expected to peak at well over 4 per cent.

Driving inflation higher were food, fuel and energy costs. The rise in food prices was "broadly based", said the ONS, though some items show an exceptionally strong upward trend – vegetables (up 3.9 per cent on the month), bread and cereals (1.1 per cent), milk (2.1 per cent), and coffee and tea (2.4 per cent).

The ONS said that the 1.6 per cent rise in food prices from November to December was the largest in any month, breaking records set in the 1970s. Other monthly rises included rail tickets (13.5 per cent) and car insurance (3.6 per cent). Air fares rose 41.8 per cent in December, a typical seasonal boost, but reflected more strongly because households now spend more of their money on air travel.

Markets have priced in a 0.25 to 0.75 point rise in the Bank of England's Bank rate by July, and a further 0.5 percentage points by the end of the year, implying a Bank rate of 1.25 per cent – adding perhaps £100 a month to the typical mortgage bill. However, many economists believe the Bank will resist the pressure, a view reinforced by comments yesterday by Paul Fisher, the Bank's executive director for markets and a member of its rate-setting committee, who said inflation was being pushed up by short-term factors. "We have to look through those short-term things, despite whatever unpopularity comes our way, to try and set the best policy rates for the medium term," he added.

Without the hike in VAT last year (from 15 to 17.5 per cent) and other duties, inflation in December would have stood at 2 per cent – the official target. Had the Government not raised VAT again on 4 January, inflation would fall further. So-called "core inflation", stripping out volatile items such as food and fuel, is 2.9 per cent, around where it was this time last year.

Still-higher inflation seems certain, leaving it double the Bank's target for most of the next year. Simon Ward, an economist at Henderson said: "The Bank's forecasting miss also reflects stubborn core inflation... Advocates of a rise in rates are not 'inflation nutters' but believe that action is required to prevent an upward drift in inflationary expectations, thereby depressing medium-term growth prospects."

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