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What are the implications of the rise in prices last month?

So, inflation is still on the rise. The government’s target measure of CPI rose from 3.0% in February to 3.4% in March.

This was mainly due to the cost of gas and petrol prices and a spike in food prices. A weak level of sterling is coupling with very high prices for oil and other commodities, and on top of that poor weather in Spain has added to food prices. Also, there may be a knock-on effect on food prices as a result of the UK becoming a no-fly zone over the past week – with dwindling supplies of some foods in the shops.

The RPI measure of inflation was 4.4% in March, up from 3.7% in February. This was affected by the same factors as the CPI but also a rise in mortgage interest payments. RPIX inflation, which excludes mortgage interest payments, was up to 4.8% in March from 4.2% in February. The recent trend can be seen in the graphic below.

Source: ONS

The latest comparable figures for CPI inflation show that the UK rate of 3.0% in February was far higher than the 1.4% for the EU as a whole.

What then are the consequences of this continued rise in prices?

Firstly, savers are suffering. Real interest rates are actually negative at the moment, and according to the Moneyfacts website the average no-notice account after tax and inflation is standing at a very enticing minus 2.82%.

Secondly, there could be an impact on wages and employment. Wage growth has been very restrained in the private sector but many wage settlements take RPI into account. With some economists suggesting that RPI could rise as high as 5%, this is likely to put some pressure on wage settlements. Given the delicate nature of the recovery this could well have a major impact on employment.

Finally, how is the Bank of England going to react? There will certainly be pressure on the MPC to raise interest rates although the governor of the Bank of England, Mervyn King, has maintained that he expects inflation to full back towards its target level over the coming months. A hike in interest rates will doubtless damage the recovery. However, the measure for core inflation, which removes the more volatile items in the measure, only rose from 2.9% to 3% last month, so perhaps pressures are not as great as they seem.

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Posted in Bank of England, Consumer Price Index, Earnings, Employment, Inflation, Interest rates, Monetary Policy Committee, sterling

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