Inflation will fall back to 2%, says Mervyn King

Inflation is likely to fall back to its 2% target "within a year" after the cost of living hit a 17-month high of 3.7% in April, Bank of England governor Mervyn King said today.

In an open letter to Chancellor George Osborne, the governor blamed high oil costs, a weaker pound and the rise in VAT to 17.5% in January for the consumer prices index (CPI) being "somewhat higher than expected" over the past year.

CPI is now almost double the Bank's 2% target but Mr King said inflation was likely to fall back as these temporary factors fade.

But the "pace and extent" of the fall is uncertain and the Bank will monitor developments closely, the governor added.

The governor said the temporary factors were "masking the downward pressure on inflation" from the slack in the economy built up in a record recession.

Mr King added that policymakers had not ruled out further emergency support to the economy, potentially paving the way for more quantitative easing.

Mr Osborne said he noted the Bank's view that the current spike in inflation would be temporary and said he expected the Bank to "remain vigilant" towards any upside risks.

The inflation rate of 3.7% for April was well ahead of the 3.5% expected by the City.

The Retail Prices Index (RPI) measure of inflation also jumped to 5.3% - the highest since July 1991 - as mortgage interest payments edged higher last month, in contrast to a year earlier when lenders passed on rate cuts.

Although the Bank expects inflation to ease back, the higher than expected figures could increase nerves among policymakers and shift them towards rate hikes to prevent the cost of living rising out of control.

Today's figures showed annual food inflation reaching 2.6% last month - the highest since last July - with broad-based price rises across meat, fruit and vegetables compared with falling costs a year ago.

The ONS added that disruption from Iceland's volcanic ash cloud last month had little upward effect on food prices.

Alcohol and cigarette duty hikes in March's Budget added to inflationary pressure, while clothing and footwear prices also rose by more than a year ago.

Food, drink and clothing added a combined 0.3 percentage points to the CPI, the ONS said, offsetting falling furniture costs.

The official figures also showed average petrol prices hitting 120.2p a litre last month - the highest since records began in 1996 - but the impact on inflation was limited, despite misery for motorists due to similar rises a year earlier.

The same factors influencing CPI were also behind the RPI rise, although the figures showed a 0.6% rise in mortgage interest payments compared to a 7.7% fall in April last year in the wake of the Bank of England cutting interest rates to a record low 0.5%.

ING economist James Knightley said he agreed that CPI inflation should move back below 2% in the next couple of years.

He said: "There are risks, though, with the threat of further sterling weakness and the potential for higher VAT putting some upside risk to this view.

"Nonetheless, given the weak growth, tight fiscal policy environment, we believe that interest rates will be on hold through the rest of this year with the prospect of only very modest interest rate rises next year."