Key MPC member sounds the alarm on inflation

A senior member of the Monetary Policy Committee warned yesterday of "tentative signs" of inflation pressure as the cost of living in the euro area hit an eight-year high.

Mervyn King, the deputy governor of the Bank of England, said the MPC would monitor inflation "extremely carefully". His remarks will fuel fears that the next move for interest rates is up.

Mr King said the UK faced two threats: an imbalance between the domestic and export sides of the economy and uncertainty over the global economic outlook. He warned that any rebalancing would be accompanied by a fall in the pound: "The existing imbalances pose risks to the inflation outlook."

He said the strength of sterling had helped drive goods inflation close to zero, allowing services inflation to rise as high as 4 per cent without threatening the target. "But there are now tentative signs of a pick-up in goods prices," he said, adding that inflation ­ excluding mortgage costs and indirect taxes ­ had almost doubled this year, to 2.8 per cent from 1.5 per cent.

Meanwhile, European inflation hit an eight-year high of 3.4 per cent in May, official figures showed. The leap from 2.9 per cent in April was driven by sharp rises in food and energy costs. Excluding these volatile components, the rate rose to 2.1 per cent.

Analysts said inflation would start falling which, combined with growing fears of recession, would allow the European Central Bank to cut rates further.

Simon Rubinsohn, chief economist at the fund manager Gerrards, said: "The economic situation is starting to deteriorate. Our suspicion is there will be a further rate cut at one of the next three meetings."

But Nigel Anderson, at Royal Bank of Scotland, said the ECB would find it hard to cut rates with inflation above 3 per cent: "Bad news on the economy may not alone be enough."

The euro fell against the pound afterGordon Brown reiterated his cautious line on euro entry. Asked whether the UK had begun the process of assessing the five economic tests on whether Britain should join, the Chancellor said: "No, what I am saying is that the Treasury will compile this assessment, and it will be completed in two years." The pound rose more than a quarter of a per cent to stand at 61.2p per euro.