Rate rise imminent as inflation overshoots target

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The Independent Online
The pound jumped and share prices fell sharply yesterday after new figures showed that inflation climbed above the Government's 2.5 per cent target last month.

The Bank of England is firmly expected to raise interest rates tomorrow, with yesterday's disappointing retail price news rounding off a series of figures suggesting that the economy was expanding too fast to keep inflation on target.

"The Bank of England cannot be happy. The Monetary Policy Committee might just delay a move until August because of the strong pound, but inflation is certainly not coming down as fast as it should have done," said Ciarn Barr, an economist at Deutsche Morgan Grenfell.

Mortgage lenders would be likely to match any increase in base rates, with a 0.25 per cent rise adding pounds 10 to the monthly payment on a typical pounds 50,000 repayment mortgage.

The prospect of a third base rate increase in three months being announced tomorrow, after the end of the committee's two-day meeting, took sterling three pfennigs higher to DM2.97 yesterday.

It also broke through the 10 French francs barrier for the first time in more than five years.

The FTSE 100 index lost more than 52 points to end at 4,758.5.

Retail prices excluding mortgage interest payments rose by 0.3 per cent during June. This took inflation on the Government's target measure up from 2.5 per cent to 2.7 per cent. The figures came as a shock as most economists had expected target inflation to decline.

A 5 per cent monthly rise in seasonal food prices during the month and a 0.7 per cent increase in petrol prices explained the overall rise. Vegetable prices normally decline in June, but wet weather across Europe had instead led to higher prices, especially for items like cauliflower and tomatoes.

Mortgage rates increases applied during June took the headline inflation rate even higher. It climbed from 2.6 per cent in May to 2.9 per cent last month.

Although City economists are almost unanimous in predicting that the Bank of England will increase borrowing costs, they disagree about whether it ought to do so. Some fear that the strong pound will prove very damaging to exports and industry.

There was a warning signal of this yesterday in the latest quarterly survey of business - carried out just before the Budget - from the Engineering Employers Federation.

It reported that new export orders were down for the second quarter running, home orders had weakened, output growth had slowed sharply and hiring of staff had come to a halt.

Alan Armitage, head of economics for the EEF, said: "Prospects for the remainder of the year will depend crucially on the level of sterling."

He warned that not only was the strong pound hitting exports directly, it was also feeding through to lower orders for suppliers.

Simon Briscoe at Nikko Europe said there was little sign of inflationary danger in yesterday's retail price figures. "Unless you believe that consumers are spending their building society handouts on fruit and veg, there is little sign of windfall-led inflation," he said. He pointed out that inflation in key consumer areas - household goods and services, and clothing and footwear - actually declined last month.

But Michael Dicks at Lehman Brothers said: "These were worrying figures even if there was some good news in the detail."

He said the strength of the pound so far ought to have resulted in a bigger drop in inflation, and suggested that retailers were taking advantage of strong demand and a higher exchange rate to boost their margins.

The Budget excise duty increases and higher prices for items such as tea and beef will tend to increase inflation again this month, but the overall picture will depend on whether food prices revert to a more normal pattern for the time of year.

Most economists expect the target measure of inflation to drift higher in coming months.

The Bank's Monetary Policy Committee, set up by Gordon Brown, Chancellor of the Exchequer, to make the month-to-month interest rate decisions that will deliver the Government's inflation target, will meet this afternoon and tomorrow morning. An announcement of its decision is expected before midday tomorrow.