Jump in inflation puts Clarke on the spot

Kenneth Clarke, Chancellor of the Exchequer, suffered a fresh embarrassment yesterday when official figures showed an unexpected jump in the headline rate of inflation.

The news followed hard on the heels of the Bank of England's prediction, earlier this week, that inflation was set to miss the Government's target.

The Chancellor rushed to deflect attention from the disappointing figures to a report on the British economy from a friendlier source, the European Commission. "The Commission highlights the Government's economic policies as the reasons for the stable and sustainable recovery of the UK economy," Mr Clarke said.

A Treasury statement picked out a paragraph in the EU report which said the Government could achieve the target of underlying inflation below 2.5 per cent by the end of the current parliament.

However, the Chancellor forgot to mention the report's next paragraph, which warns of the danger of the economy overheating. "This may require a tightening of monetary policy," it continued.

City experts were certainly disappointed with the inflation figures, even though they showed the biggest one-month drop in the price of clothing and shoes since 1947, when Christian Dior introduced his revolutionary New Look.

Most economists still expect the target inflation measure to fall below the key 2.5 per cent level during the next three months, but to start increasing subsequently.

Jonathan Loynes, UK economist at HSBC Markets, said: "This was a setback for Mr Clarke." But he said better news in the pipeline over the next few months would allow the Chancellor to avoid having to raise borrowing costs ahead of the general election.

Indeed, the Chancellor had been informed about the inflation figures on Tuesday afternoon, well before he announced on the day of the Bank's Inflation Report that he saw no need for higher interest rates.

Retail price inflation rose to 2.8 per cent in January from 2.5 per cent in December, with most of the increase due to a rise in mortgage rates during the month compared with a decline the previous January. The target measure, which excludes mortgage interest payments, was unchanged at 3.1 per cent, rather than declining as expected.

There was a record-breaking fall in the price of shoes and clothing, down 5.8 per cent in January. It was the biggest drop since figures began in 1947. Although the price of clothes has risen nearly seven-fold during the past half-century, their level is the same now as a year ago.

The price of household goods also fell sharply. The 3.6 per cent decline was the biggest since 1956. But offsetting these drops in prices on the high street, there were increases in non-seasonal food prices, car insurance, second-hand cars and a variety of services.

"Service sector inflation has at last responded to the stronger demand of the last year or two," said Simon Briscoe at Nikko.

Adam Cole at brokers James Capel said the figures strongly supported the Governor of the Bank of England in his call for higher borrowing costs.

The Chancellor, however, insisted that his views and the Governor's were very close. "The Governor of the Bank and myself are entirely agreed that there is only a small difference of judgment between us - one quarter of one per cent. He thinks I put a little too much emphasis on the present strength of sterling and I think he puts a little less emphasis on the strength of sterling," Mr Clarke told MPs yesterday.