Inflation surprise makes Bank of England rate rise almost a certainty

Inflation surprise makes Bank of England rate rise almost a certainty

Victory is delayed. Inflation had been expected to fall below 10% but there was a shock on Wednesday morning when that didn’t happen, after the annual growth in food and nonalcoholic beverage prices unexpectedly jumped in March to its highest level since 1977.

Fresh fish, cooking oil and biscuits all rose in price to push up the overall annual increase in food bills from 18% in February to 19.1% in March.

Inflation is still on track to halve by the end of the year – allowing ministers to boast of its near defeat – because the full effect of a drop in wholesale gas prices has yet to feed through into the overall rate. Along the same lines, policymakers at the Bank of England are expected to say when they meet next month that inflation remains on course to slide below its 2% target next year.

However, City economists agree that while inflation is now back on a downward trajectory – dipping to 10.1% in March after a surprise rise to 10.4% the previous month – there is a 97% chance the central bank’s monetary policy committee (MPC) will increase interest rates one more time in May.

The MPC is likely to be unmoved by the plight of mortgage payers when a majority of its nine members vote for an increase of 0.25 percentage point in the base rate to 4.5%.

If they are to come close to eventually achieving their target of annual prices growth of 2%, the rate-setting committee believes its only recourse must be to increase borrowing costs and further dampen consumer spending. Only then does it expect shops to begin to restrict price increases.

There is another factor weighing on the MPC – the ugly comparison with inflation among the UK’s main competitors. In the eurozone it stands at 6.9% and only 5% in the US.

Kitty Ussher, the chief economist at the Institute of Directors said these trends meant “the Bank of England’s job is not yet done”, highlighting issues with core inflation – a measure that strips out volatile elements such as fuel and food prices, which has become the focus of the MPC’s concerns in recent months.

“While it is a relief that the headline rate of inflation is now pointing downwards again … the improvement this month is predominantly due to falling transport prices which, although welcome, hides an underlying stickiness in core inflation, which at 6.2% has not yet started to fall,” she said.

Why then are prices still rising at such a high rate? The head of the Unite union, Sharon Graham, is certain the cause is price gouging by big companies keen to pass on all the rise in costs they face and then some.

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Paul Donovan, the chief economist at UBS wealth management, endorses the view that corporate greed plays a part, although he says the latest inflationary pressures emanate from convenience stores as much as the supermarkets.

Wheat prices cannot explain the soaring cost of bread. Like most commodities, they have fallen back dramatically from last year’s peaks.

So maybe it is the level of wages – which on average accounts for about 70% of a firm’s costs – that is behind the relentless increases in shop prices. But annual private sector earnings growth is running at just under 7%. Although that is a historically high level, it is not enough to determine the current level of price rises.

Although markets believe it is almost certain the MPC will raise rates on 11 May, the director of economics at the Institute of Chartered Accountants in England and Wales, Suren Thiru, is not so sure. He suggests the potential damage a further interest rate rise would inflict could lead to a bigger split in the MPC vote, leaving the outcome uncertain.

Last time, two MPC members voted to keep rates on hold. Next time more could join their ranks. However, anything but a rise would seem to be an unlikely scenario, albeit one that borrowers will be praying for.