Treasury target missed as inflation hits 4.7%

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Even as the economy slides towards recession, higher prices for gas and electricity have helped drive inflation to a new peak of 4.7 per cent – up from the 4.4 per cent recorded in July. The older retail price index fell slightly to 4.8 per cent.

The news prompted the Governor of the Bank of England, Mervyn King, to send his second open letter of explanation to the Chancellor in three months, as required by law. Mr King said that inflation will stay "markedly" above its official target of 2 per cent "until well into 2009... I continue to expect, therefore, that I will be writing further open letters to you over the next year."

The Governor added that annual inflation will peak soon at "around 5 per cent" and that he is "determined" to push the rate back to its 2 per cent target.

Most observers expect inflation to peak in the autumn at a little over 5 per cent as the high commodity prices prevailing earlier in the year continue to feed through to the shops.

However, the recent decline in these costs, in which the price of a barrel of oil has dipped below $80 recently, way off its $147 high, and the rapid cooling in the economy should lead to inflation falling quickly.

David Blanchflower, a member of the Bank's Monetary Policy Committee, predicted a few weeks ago that inflation will soon "plummet like a stone".

Economists expect petrol prices to drop by about 15 per cent over the next few months, sufficient to knock 1 per cent off the headline rate of inflation. But the sharp depreciation of sterling – down 5 per cent in a month against other currencies – may slow that fall.

The Bank has kept its official rate of interest at 5 per cent since April, although the more recent trend in discussions within the MPC and in the Bank's official reports has been taken to be more "doveish" – favourable to rate cuts.

Most analysts expect a reduction of a quarter percentage point in November, to coincide with the publication of the Bank's next Inflation Report, once inflation is seen to be on a downward path. Some expect a bank rate as low as 3.5 per cent by the end of next year, thought the impact of the credit crunch may prevent some of this.