Inflation 'could rise back up towards 3% by next year'

Struggling households are unlikely to enjoy the benefits of softer inflation for much longer despite a dip in the cost of living last month, economists warned today.

Smaller rises for utility bills and clothing prices compared with last year helped the consumer price index (CPI) rate of inflation edge down to 2.5% in August from 2.6% in July, the Office for National Statistics (ONS) said.

But the rising cost of petrol and diesel at the pumps maintained upward pressure on inflation in August and will fuel fears that the rate will not fall as rapidly as the Bank of England hopes, tightening the squeeze on households.

And economists warned droughts in the United States are likely to mean higher food prices while more energy price hikes are in the pipeline this autumn. Higher university tuition fees will also add to inflation next month.

Victoria Clarke, economist at Investec, said inflation could rise back up towards 3% by the middle of next year.

She said: "From here we do expect inflation to moderate a touch further.

"However, we should caution that we do expect this trend to turn upwards again soon, with sources of upward pressure emerging over the months ahead including university tuition fees, higher food prices following the recent US droughts and higher pump fuel prices too."

The figures were published amid reports the Government is considering linking hikes in benefit payments to average pay rather than inflation. September's CPI figure is typically used to determine the following April's rise in the basic state pension.

A Department for Work and Pensions (DWP) spokeswoman said any changes to how benefits hikes are calculated will be looked at by the Government later this year.

The CPI rate of inflation hit a 31-month low in June after steadily declining from a peak of 5.2% last September but unexpectedly rose to 2.6% in July.

The forecasts will trouble the Bank of England, which is tasked with keeping inflation as close to the Government's 2% target as possible, after it previously said the rate would fall throughout 2012 and into 2013.

The Bank's Monetary Policy Committee (MPC) stepped up its quantitative easing (QE) emergency support programme in July, from £325 billion to £375 billion, which has drawn criticism by pension campaigners due to its adverse impact on inflation.

Colin Edwards, economist at the Centre for Economics and Business Research (Cebr), said: "On the whole, today's figures represent marginally better news for UK consumers. The more consumers are able to buy with their incomes, the higher their living standards are likely to be.

"However, looking forward, it seems unlikely that consumers will be provided with similar respite from further falls in inflation."

The most significant upward pressure on prices came from transport, specifically motor fuels, the ONS said.

Average petrol prices increased by 3.5p a litre to 135.1p in August, while diesel rose by 3.3p to 140.3p, which both compare with smaller rises last year.

There was only a small upward effect from rising food prices, mainly from bread and cereals, although analysts said the impact from a weak Northern Hemisphere harvest will eventually start to feed into prices.

Furniture, household equipment and maintenance prices rose by 0.8% in August, less than the 2% rise in the same period last year, with the main downward effect coming from lounge furniture and tufted carpets.

There was also a slight downward effect from non-durable household goods such as bleach and household cleaner cream.

The main downward effect came from gas and electricity bills which were unchanged this year, compared with rises of 1.7% and 1% respectively last year.

Meanwhile, clothing prices rose by 2.8% between July and August but this compared with a record 3.7% rise a year ago. The most significant downward pressure came from menswear.

Other measures of inflation also fell with the retail price index dropping to 2.9% in August, from 3.2% in July.

A spokesman for the Treasury welcomed the figures. He said: "Inflation coming down is good news for households and business. The rate of CPI inflation has now more than halved since its peak last September, bringing welcome relief to budgets."

The pressure faced by households was underlined by jobs market data released last week as average earnings growth in the quarter to July slowed to 1.5%, far behind the rate ofinflation.

Labour Treasury spokeswoman Catherine McKinnell said: "This small fall in the inflation rate is welcome, but families and pensioners are still facing a big squeeze on their incomes as prices continue to rise faster than wages.

"And far from helping to ease the squeeze, the Government's unfair policies are making things worse. While millionaires get a tax cut, millions of families and pensioners are being hit hard by things like the VAT rise, deep cuts to tax credits and the granny tax.

"People on low and middle incomes are paying a heavy price for the Government's failed policies which have pushed us into a double-dip recession and led to borrowing rising by a quarter so far this year. We need a change of course and a plan for jobs and growth now to kick-start the economy, get people back to work and so get the deficit down."

TUC general secretary Brendan Barber said: "Inflation is not falling fast enough, particularly as wage growth is so anaemic.

"Real wages have been shrinking for nearly four years now and the prospect of an ease in living standards any time soon looks remote.

"Worse news lies ahead for low-paid workers if the Government decides to freeze benefits. The combination of low wage growth, higher indirect taxes, in-work benefit freezes and tax credit cuts add up to an unprecedented attack on the living standards of low-paid workers and their families."

PA