Inflation rise adds to pressure for rates hike

A bigger-than-expected rise in inflation today heaped more pressure on the Bank of England to increase interest rates as economists warned the cost of living is likely to continue to soar.

The Consumer Prices Index (CPI) rate of inflation rose to 3.7% last month, its highest level since April and up from 3.3% in November, the Office for National Statistics (ONS) said. Economists were expecting the rate to rise to 3.4%.

Surging food costs, nudged up by the weather disruption, energy bills and petrol prices led to a month-on-month prices increase of 1% between November and December, the biggest monthly rise since records began in 1996, the ONS added.

The figures will provide little cheer for homeowners as some analysts predict the Bank of England will be forced to lift interest rates as early as the summer to curb inflation.

The figures also prompted a warning from union leaders that higher inflation could spark claims for pay rises in the coming months, applying further pressure on the Bank and its Governor Mervyn King to stop inflation spiralling out of control.

The Bank, which is tasked with bringing inflation down to a 2% target, has resisted lifting interest rates from historic lows of 0.5% as the wider economy battles with slow growth. The rate of CPI has been above its 2% target every month since November 2009.

Policymakers at the Bank's Monetary Policy Committee (MPC) believe the period of stubbornly high inflation is being caused by temporary factors.

As the Chancellor's belt-tightening austerity measures start to kick in, the Bank will be under further pressure not to throw the fragile recovery off course.

Sterling was around 1% higher against the dollar as traders factored in the chances of an earlier-than-expected rise in interest rates.

The rate of inflation is likely to soar past 4%, economists said, as December's figures did not include the impact of the VAT hike from 17.5% to 20%, which came into force on January 4.

Philip Shaw, chief economist at brokers Investec, said the rate of inflation could hit 4% next month and remain above target in 2012.

He said: "A sustained rise in commodity prices would probably result in inflation remaining above the 2% target throughout next year as well, despite the effects of this year's VAT hike dropping out of the calculation.

"Given this background it will become more and more difficult for the MPC to stave off a tightening in monetary policy."

Alan Clarke, economist at BNP Paribas, predicted a rate rise as early as May. He said: "It confirms my suspicion that the first rate hike will come this year, the only question is how soon. Our call is August, but clearly there is a risk it comes as soon as May."

Howard Archer, chief UK and European economist at IHS Global Insight, said the Bank may have to lift interest rates in the short-term to prove it is paying attention to the troubling figures.

He said: "Despite the undeniably significant rise to growth coming from the fiscal tightening that is now increasingly kicking in, there is mounting pressure on the Bank of England to enact at least a token near-term interest rate hike to send out the message that it has not taken its eye off the inflation ball."

But Brian Hilliard, economist at Societe Generale, said despite the pressures, he did not expect an interest rate hike next month.

He said: "The Bank of England has already predicted in the December minutes that the inflation rate would touch 4% in the spring so is unlikely to be bounced into a February rate increase by today's data or by January's, which should be provided to the MPC in time for that meeting."

The rise in inflation saw TUC general secretary Brendan Barber call for Chancellor George Osborne to reconsider the VAT hike.

He said: "Fuelling inflation with a VAT hike will hit workers in their wage packets and shopping receipts. This tax rise is bad for working families and damaging for the economy too."

The rise was driven by a 1.6% increase in the price of food, the highest rise for a November to December period, and a 3.6% surge in transport costs, the highest monthly increase on record.

The big freeze pushed up the price of vegetables in December as supplies were choked by disruption to distribution channels and crop damage.

The ONS said cauliflowers were particularly badly hit by the Arctic weather, which caused a shortage that led to a 75.6% rise in prices.

There were price hikes across most bread and cereals, aggravated by the wildfires that wrecked Russia's harvest and caused the country to impose an export ban.

The price rises brought in by utility companies also started to feed through to consumers in December, with gas particularly badly affected, pushing up the cost of housing and household services by 1.4%.

Five of the "big six" energy firms - Scottish & Southern, Scottish Power, British Gas, npower and E.ON - have all unveiled bill hikes in the last two months.

Petrol prices also continued to rise to £1.22 per litre, the ONS said.

Air fares were up by 41.8% between November and December, compared with a 41.7% rise in the same period a year ago.

But there was downward pressure on pricing from clothing and footwear, where prices fell by a higher-than-average 1.9% as the havoc caused by the snow forced retailers to compete for sales.

Other measures of inflation also increased. The Retail Prices Index, which includes mortgage repayments, rose to 4.8% from 4.7% in November.