Surge in goods prices dashes hopes of rate cut

Inflation hit its highest level for almost five years last month, denting hopes that the Bank of England might announce a surprise cut in interest rates next month.

Official figures published yesterday showed the rate excluding mortgage costs – the measure the Bank of England uses when setting rates – hit 3 per cent for the first time since May 1998. The headline figure, which is used in annual pay negotiations, rose to a two-year high of 3.2 per cent.

The increase was driven by the first increase in goods prices for a year amid signs the recent sharp declines in clothing and seasonal food prices were ending. The largest single contribution was a sharp jump in the cost of clothing and footwear, which jumped 2.3 per cent on the month and contributed almost a third of the overall rise. Goods prices rose 0.1 per cent, which was their first rise since April last year. The pace of inflation for services slowed to a 14-month low of 4.5 per cent.

"The main worry for the Bank is that the latest rise in inflation feeds through into greater wage pressures both in the public and private sectors," Simon Rubinsohn, chief economist at stockbrokers Gerrard, said . "It is a risk that cannot be ignored."

The rise in inflation was larger than the City expected and analysts said it could go higher in the coming months.

Recent hikes in petrol prices, the introduction of the London congestion charge and increases of up to 50 per cent in council tax could push the rate higher.

The Bank of England recently forecast inflation would overshoot its 2.5 per cent target – albeit not as high as 3 per cent – before falling sharply next year.

Against that background, economists said the Monetary Policy Committee would be more worried about signs of further economic weakness that would justify another rate cut. "Today's data should not have represented a surprise to the MPC," Alan Castle at Lehman Brothers said. "Oil prices should see a fall in inflation back towards the target."

Yesterday the oil price tumbled as much as 10 per cent as traders hailed the imminent declaration of war against Iraq as an end to the uncertainty that has driven up prices over recent weeks.

Brent crude slumped as much as $3 a barrel, or 10 per cent, to a three-month low of $26.40. It later steadied at $27.45 or 6.9 per cent down on the day.

The rebound in share prices that saw the index of top UK companies enjoy its largest three-day rise in 20 years finally fizzled out. The FTSE 100 index, which has risen 14 per cent since last Thursday, closed up 25 points having been 87 points ahead at one time.

Meanwhile the Financial Services Authority told investors yesterday to prepare for greater-than-usual volatility in share prices on Friday because of the expiration of futures and options. The expiry of contracts on index futures and equity options – known in the City as "double witching" – caused huge volatility last September.

"It is possible that similar conditions could reoccur during the expiry on 21 March," the FSA said. "Firms may wish to consider the limits they may set on where they will be willing to trade."