Rise in rate of inflation puts Chancellor to test

DIANE COYLE

Economics Correspondent

Figures released yesterday brought an immediate test of the Chancellor's Mansion House commitment to bring inflation below 2.5 per cent.

The target measure of inflation increased more than expected to 2.7 per cent last month, and it is forecast by the Bank of England and others to continue rising for the rest of the year. But the extra room for manoeuvre in the target means City economists do not expect Mr Clarke to raise base rates in the near future despite the upward trend in inflation. The recovery is already slowing, as a very modest rise in retail sales in May confirmed yesterday.

Mr Clarke's new target was widely interpreted as an easing of the Government's tough anti-inflation line. The 2.5 per cent long-term aim for retail price inflation excluding mortgage interest payments is seen by the City as an average rather than an upper limit. This means inflation will be allowed to vary up to the top of the 1-4 per cent range - or perhaps higher - in practice.

Bill Martin, chief economist at UBS, said the Chancellor's speech had been deliberately ambiguous, sounding tough while actually relaxing the target. "The language would have done George Orwell proud. All inflation targets are equal but some are more equal than others," Mr Martin said.

The prospect of more elbow room on base rates, helped by big gains on Wall Street, took the FT-SE 100 index up 30.6 points to 3,370.4. But gilts ended lower because of inflation fears.

Retail prices rose 0.4 per cent in May, with the annual headline rate of inflation up to 3.4 per cent. Inflation on the target RPIX measure - the RPI excluding mortgage interest payments - rose to 2.7 per cent.

The main culprit was a 1.3 per cent jump in the price of non-seasonal foods, the biggest monthly rise since January 1982. One explanation was the end of special promotional offers in supermarkets for items such as beef and turkey. "Retailers are now less prepared to slash prices to gain volumes," said Adam Cole, of James Capel.

Another cause was the effect of the weak pound on import prices - precisely the danger the Bank of England warned about in its last Inflation Report.

The price of household goods rose 1.1 per cent in May, again partly because of the higher cost of imported commodities. However, the separate retail sales figures brought comfort here. The volume of household goods sold in May fell, suggesting consumers were not willing to pay the higher prices. However, the main sources of downward pressure on inflation last month were lower house prices and falling utilities charges.

Retail sales volumes staged a slight recovery, rising 0.2 per cent. Figures for March and April were revised up. But in the past six months, sales volumes have been flat.