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Rapid rise in UK inflation

The Consumer Prices Index (CPI) rose to 3.5% in January from 2.9% in December. According to the Office of National Statistics (ONS) this is the second largest ever increase in the annual inflation rate between two months. It follows on from the record increase of 1.0% in the annual inflation rate between November and December.

The reason for the increase was due to the restoration of the VAT rate in January to 17.5% and the increase in the price of petrol. This time last year petrol was 86.3p a litre and has now risen to 110.9p per litre. There was also an increase in some food prices with cauliflowers rising in price by 59.7%.

Because the CPI deviated more than 1% from its official target rate of 2.0%, the governor of the Bank of England was forced to write a letter of explanation to the Chancellor. In this, Mervyn King wrote that the committee saw this as a “temporary deviation”. He said: “Although it is likely to remain high over the next few months, inflation is more likely than not to fall back to the target in the second half of this year, as the short-run factors wane and the influence of spare capacity builds.”

The RPI measure of inflation, which is often quoted in wage negotiations, rose from 2.4% in December to 3.7% in January. The largest upward contribution to this change came from housing. This is because mortgage interest payments rose this year but had fallen significantly a year ago, when the majority of lenders passed on the decline in Bank rate which fell from 3.0% to 2.0%.  This is the highest RPI figure since October 2008 and is the first time that RPI has exceeded the CPI figure since August 2008.

Source: ONS

The RPIX measure, which excludes mortgage interest payments, rose from 3.8% in December to 4.6% in January. And, what is particularly of interest, is that underlying inflation which excludes more volatile elements such as food and fuel, rose from 2.8% to 3.1%. This suggests that there are underlying pressures on prices, which could partly be due to the weakness of sterling, which is pushing up import prices.

UK inflation can be very difficult to budge and when looking at the December figures the UK CPI inflation rate stood at 2.9% compared to only 1.4% in the EU as a whole.

There are big implications of this jump in inflation for savers. Moneyfacts, who are experts in personal finance, suggest that with a typical savings account offering instant withdrawal only offering 0.73% in interest, basic rate taxpayers are losing the equivalent of 2.92% a year, and higher rate taxpayers are losing 3.06%.

Although the Bank feels that inflation will be back below target in the coming months, this could be upset by attempts to rectify the budget deficit after the election. Many City economists now believe that VAT will be raised to 20%, which will have a large inflationary impact if it comes to pass.

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Posted in Bank of England, Consumer Price Index, Inflation, Monetary Policy Committee, savings, sterling

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