Inflation to pass 4%, Governor warns

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The Independent Online

Households were tonight warned that soaring food prices and energy bills could push the annual rate of inflation to more than 4 per cent by later this year.

The gloomy forecast came after the Consumer Prices Index (CPI) surged to 3.3 per cent in May - the highest since the inflation yardstick began in January 1997.

But the Bank of England signalled borrowers may be spared rate hikes to tackle the impact of soaring oil and food prices.

The Bank Governor Mervyn King said CPI could rise to more than double his 2 per cent target later this year as record oil prices and the prospect of higher gas and electricity bills hit home.

Fears have grown in the City that interest rates could rise to combat the price pressure, but Mr King said attempting to bring inflation back down in the next 12 months would cause "unnecessary volatility".

Mr King was forced to write a letter of explanation to Chancellor Alistair Darling as CPI rose more than 1 per cent above the Bank's target. He expects it to remain at that level until "well into 2009".

Although the Governor said the path of rates was "uncertain", he added that there was no "generalised rise in price and wages" and experts took his comments as a signal that borrowing costs may not have to rise.

London's FTSE 100 Index rose as much as 2 per cent. Investec chief economist Philip Shaw, who predicts rates will be held at 5 per cent for the rest of the year, said: "The Governor managed to soothe markets' worst fears, namely that the Monetary Policy Committee could be willing to risk bringing the economy down sharply in order to drive inflation down rapidly."

Mr Darling replied that the Government was working on a "genuinely global" response to soaring food and oil costs but was determined to keep a lid on inflationary pay deals.

"To return now to inflationary pay settlements would undermine rather than raise people's living standards with a damaging circle of wage increases eroded by steadily rising prices," the Chancellor said.

The Governor expects inflation to peak later this year before falling back towards the target, although he stressed this forecast was based on no further unexpected rises in oil prices.

But some analysts have predicted oil - which hit a new record yesterday of almost 140 dollars a barrel - could rise as high as 250 dollars.

ING Bank's James Knightley said: "The big unknown remains what will happen to energy costs, but assuming weaker global economic activity, we believe that the pace of increases in commodity prices and energy costs will gradually slow, reducing the inflation impulse."

The British Chambers of Commerce said raising rates in response to a short-term surge in commodity prices would be "totally misguided".

The TUC's head of economics, Adam Lent, added: "Putting up interest rates now would do nothing to damp down inflation and would instead slow the economy.

"There is no point in the UK economy taking medicine with nasty side effects if it doesn't produce a cure."

The Bank's nine-strong Monetary Policy Committee (MPC) has faced a balancing act between cutting rates too sharply and adding to inflation risks and causing a sharp slowdown by keeping rates too high. Mr King said the MPC would make month-by-month judgments on the path of interest rates.

The Governor highlighted that in the year to May, world agricultural prices rose 60 per cent with UK food retail prices up 8 per cent. Oil prices rose by more than 80 per cent on average while fuel prices in the UK soared 20 per cent.

Meanwhile, wholesale gas prices are up 160 per cent and households have faced rises of around 10 per cent in gas and electricity bills.

In contrast to his letter last year to former Chancellor Gordon Brown, Mr King said today's letter was likely to be the first in a sequence as inflation remained above target.

A further slowing of the economy was likely this year as higher prices and the credit crunch weighed on household spending, Mr King said.

The Office for National Statistics said the rising cost of meat and vegetables combined with higher energy bills than last year led to the latest jump in inflation from 3 per cent to 3.3 per cent.

Although CPI has only been recorded for 11 years, the previous comparable annual inflation readings were last as high in July 1992, the ONS said.