Inflation surge casts doubt on Bank decision to cut rates

Inflation surged to an eight-year high last month and is now threatening to exceed the Bank of England's near-term forecast, raising questions over the wisdom of its interest rate cut two weeks ago.

Official figures showed yesterday that consumer price inflation rose 2.3 per cent in July from a year ago, the highest annual growth rate since the data series began in 1997. It was the first time inflation exceeded the Bank's 2 per cent target since it adopted the consumer price index as its main inflation measure in December 2003. Until June, when it rose to 2 per cent, inflation had always been below the target.

The figures surprised City analysts and pushed the pound higher while interest rate futures fell sharply, as traders figured that further interest rate cuts were off the agenda for now.

Chris Iggo, at the insurer Axa, said: "The inflation data make it highly unlikely that the Bank will be able to cut interest rates again. Inflation is now running above the government's 2 per cent target by a margin that was not expected when the Bank cut interest rates earlier this month."

In its quarterly inflation report published a week ago, the Bank forecast inflation would average 2.15 per cent in the third quarter, but the latest figures suggest the forecast could be missed.

George Buckley, at Deutsche Bank, pointed out that inflation would have to fall to 2.1 per cent or below in August and September to meet the Bank's estimate. But he added that recent experience was not encouraging as the market had underestimated inflation in six of the last nine months.

The bulk of the rise in inflation in July was caused by petrol prices, which jumped to a record high of 87.5p a litre in the wake of soaring oil prices. More worryingly for the Bank, higher furniture prices and banking charges such as overdraft fees also contributed to the increase.

The jump in petrol costs added 0.13 percentage points to the annual inflation rate in July while furniture and other household goods, including white goods, contributed 0.1 percentage points.

The rise in inflation hit most items, with overall goods price inflation rising to 0.5 per cent from 0.2 per cent in June and inflation in the service sector hitting 4.8 per cent, its highest annual rate since December 2002. Crude oil prices have been hitting new record highs this month amid ongoing supply and security concerns, and reached $67.1 a barrel last Friday but slipped back to $66 yesterday. That has pushed petrol prices even higher to above 90p a litre, suggesting inflation could climb further this month and beyond.

Last week's inflation report dampened hopes for further quick interest rate reductions when the Bank predicted a strong economic recovery and warned that inflation would far exceed its 2 per cent target if it cut interest rates to 4 per cent as markets assumed.

Geoffrey Dicks, at Royal Bank of Scotland, said: "Our reaction to last week's inflation report was 'So why did they cut rates?' The inflation data, which were not known to the Bank at the time, might prompt the question again."

The Bank cut rates two weeks ago by a quarter percentage point to 4.5 per cent, the first reduction in two years, in response to a sharp slowdown in the economy. Many analysts had predicted a further rate cut before the end of the year, but that looks less likely.

Soaring energy costs also pushed up consumer prices in the US in July to the highest rate in three months, and inflation in the dozen-nation eurozone stands above the European Central Bank's 2 per cent threshold .