Surge in factory gate inflation hits hopes for rate cuts

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Factory gate inflation hit a 17-year high in March, the Office for National Statistics said yesterday, posing a serious threat to the Bank of England's inflation targets and its ability to cut interest rates further in the coming months.

The cost of goods produced by manufacturers rose by 6.2 per cent on an annual basis in March, significantly ahead of economists' forecasts and well above February's figure of 5.9 per cent.

The ONS said the rise followed soaring increases in the cost of materials and fuels bought by the manufacturing sector, with input prices up 20.6 per cent over the year to March, the highest figure since records began in 1986. A 62.5 per cent hike in the cost of oil contributed just over half of this rise, with rising food prices making a significant contribution. Rising producer prices also reflect the impact of last month's Budget, which imposed higher excise duties on tobacco and alcohol.

Howard Archer, chief UK and European economist at Global Insight, said the figures would put huge pressure on the Bank's Monetary Policy Committee, which is charged with keeping the headline rate of inflation, as measured by the consumer price index, within a single percentage point of 2 per cent. While the MPC last week cut base rates by 0.25 percentage points to 5 per cent, citing concerns about the continuing effects of the credit crisis and concerns about a global economic slowdown, it warned there were serious inflationary pressures in the short term.

"This is a pretty horrid set of data that will not go down at all well at the Bank," Mr Archer warned. "Going forward, the Bank of England will be desperately hoping manufacturers' pricing power will be diluted by likely weaker activity and intensifying competition ... [but it] cannot afford to relax on the inflation front and continues to have limited scope to cut interest rates."

The Bank's Governor, Mervyn King, has already warned this year he fears he may have to write to the Chancellor for a second time explaining why the inflation target has been missed. Even so, the MPC has justified three interest rate rises since last December by arguing that a slowdown in the economy will bring inflationary pressures under control during the second half of the year.

However, David Page, an economist at Investec, warned that the scale of the increase in producer prices was a surprise. "They're pretty ugly," he warned. "Some of that is Budget-related, but the figures show meaningful pressure coming through that is going to feed into the consumer price index over the coming months and clearly vindicates some of the concerns the Bank has about the inflation outlook."

Vince Cable, the Liberal Democrats' Treasury spokesman, said rising inflation was already squeezing household budgets. "There is a real danger that high levels of inflation will worsen the current debt crisis in the UK, further damaging growth," he said.

The ONS is due to publish March's CPI inflation figures today, providing further evidence of the extent to which the headline rate is creeping upwards. Inflation rose to 2.5 per cent in February, the highest rate for nine months, though much of the increase was due to a new method of calculating home energy costs.

Inflation has to some extent been kept in check by the limited extent to which retailers have felt able to pass on cost pressures to consumers. Geoffrey Dicks, an economist at Royal Bank of Scotland, said: "It is not getting any easier to pass these prices through to the consumer, which is just as well given the pressure on the MPC to keep cutting rates."