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Inflation continues to climb

CPI annual inflation was 4.0% in January, rising from 3.7% in December, according to figures released by the ONS today. The ONS said that: “Two of the main factors that had an impact on the January data are the increase in the standard rate of Value Added Tax (VAT) to 20 per cent and the continued increase in the price of crude oil.” VAT rose from 17.5% to 20.0% on the 4th January 2011.

Factors forcing inflation higher included the price of petrol which at £1.27 per litre in January was at a record high; a 1.4% increase between December and January in the restaurant and café sector, which equals the record monthly increase, driven by higher VAT; and alcoholic beverages which rose by 6.7% between December and January and was another record increase. The recent changes can be seen in the graphic below.

Annual inflation rates - 12 month percentage change. Source: ONS

Other figures show that in the year to January RPI annual inflation was 5.1%, up from 4.8% in December and RPIX inflation, which excludes mortgage interest payments, was also 5.1%, up from 4.7%. When compared to the EU, latest figures for December show UK CPI inflation was 3.7% compared to a figure of 2.6% for the EU as a whole.

On top of this it looks as though inflationary pressures are not going to ease any time soon. Producer prices released this week show that output price ‘factory gate’ inflation for all manufactured products rose 4.8% in January 2011, whilst input price inflation, what firms have to pay on their raw materials and intermediate products coming in, rose to an annual rate of 13.4%, up from 12.9% in December.

What are the consequences of the rise in inflation? Firstly, CPI inflation has been above the 2% figure which the Bank of England is meant to target by at least one percentage point, for the last fourteen months. One side effect of this is that the governor of the Bank will have to write a letter of explanation to the Chancellor, following on from the three which he had to write last year. But, most importantly, this will put more pressure on the members of the Monetary Policy Committee to raise interest rates in the near future.

So far the MPC has been holding back because it regards the inflation rise as temporary and given the time lag that interest hikes take to work through the economic process, they feel that by the time a rise in interest rates starts to bite will be just at the time when inflation is falling anyway. Such an event would be damaging to the economy at a time of fiscal tightening.

Secondly, there will be more pressure from the unions for wage increases. TUC Deputy General Secretary, Frances O’Grady is to say in a speech today at an event called: The Pay Challenge in 2011: Pay bargaining in an age of austerity, that: “The economic outlook is grim and workers are facing an unprecedented assault on their living standards. Thanks to the increase in VAT, real wages this year are likely to be no higher than they were in 2005.”

He will go on to say: “At a time when workers are struggling with benefit cuts and tax rises, falling real wages mean suppressed demand. We face a dangerous vicious circle of weak consumer spending, sluggish demand, and a depressed economy. Without higher wages, we won’t be able to break that destructive cycle.”

Although the TUC plans to mount a major march in London on 26th March, protesting the current cuts, it is probable that many workers will be more concerned with retaining their jobs than fighting for higher wages in the current situation.

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Posted in Consumer Price Index, Inflation, Interest rates, Monetary Policy Committee

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