According to the Office for National Statistics, the rapid increase in petrol and food prices were responsible for the annual increase in the cost of living picking up in October.
The consumer prices index (CPI) rose from 1.8 to 2.1 per cent. It is the first time it has been above its two per cent target since June. The all-items retail prices index moved up from 3.9 to 4.2 per cent.
Analysts did not discount further rises in food and petrol prices while a combination of five increases in interest rates and the impact of the credit crunch on the UK’s financial and business sectors were seen to have slowed growth. Inflation is expected to rise further in the near term.
Interest rates have been held at 5.75 per cent since being raised by a quarter-point in July, but recent weakness in the service sector, manufacturing and in house prices had persuaded many into believing that interest rates were about to be slashed.
A breakdown of the inflation figures from the ONS showed that petrol was the single biggest factor in last month’s increase in the CPI measure of inflation. The price of a litre of unleaded petrol rose by 2.7 pence last month compared with a 5.2p-a-litre drop in the same month a year earlier. The combined effect meant that petrol prices accounted for 0.29 points of the 0.3 point increase in CPI inflation.
Food also drove up inflation last month, the ONS added, with big increases in the price of meat and fruit and small rises for bread, cereals, milk, cheese and eggs.
Officials said inflation last month would have been still higher had it not been for a sharp fall in the cost of household gas and electricity bills, which were rising in the autumn of 2006 but fell this year. The cost of electricity, gas and other fuels fell four per cent on the year, the biggest decline since 1998.
It was in this backdrop that the Bank of England announced its inflation report on Wednesday giving rise to speculation that two interest rate cuts will be needed next year to stem an economic slowdown. Mervyn King, the Bank governor, said the global credit crunch would further slow down UK growth early next year, with risks of a further fallout from falling share prices and currency tensions in the world economy.
This was taken as a clear signal that rates would soon come down. Mr King said decisions on rates would be difficult in the coming months and that would crucially depend on the extent of the slow down in the economy. The bank’s forecasts showed inflation falling well below its two per cent target in two years if UK interest rates were held at 5.75 per cent but on target if the bank cut rates twice in 2008.
Mr King said the forecast slowdown was “certainly sharp compared with a very small movement that we have seen over the last 10 years”.
The gloomy prospects for growth at the start of 2008 flow from credit conditions which are expected to become even more difficult than they are at present for companies and households. As more expensive borrowing would impact adversely corporate investment, the property market and construction, households are expected to go slow on borrowing and focus more on saving.
Mr King also made it clear that he thought equity markets had not adequately priced risk yet and warned that a significant risk to the world economy lay in the threat of falling equity prices. He said the tensions in global currency markets would continue as the huge trade imbalances began to unwind.
He said he came came back from the IMF meetings in Washington recently “more concerned about the implications of these tensions precisely because the unwinding of the imbalances is not just a hypothetical prospect out there, but is happening now and I think this is a major concern,”.
The bank’s inflation report has prompted many here to expect lower rates before February so as to stop in time the expected slowing down in the economy before it is too late.
The report is seen to be so pessimistic on growth that many analysts said the bank would cut rates before the end of the current year, especially if mortgage approval figures and service sector surveys continued to be weak.
Some analysts fear that if the slow down continued over two quarters a deep recession could set in the economy leading then to stagflation.
The inflation report says the bank believes the key indicators are, “the price and quantity of credit, asset prices and timely indicators of consumption and investment spending”. It implies that if the borrowing rates charged by banks continue to rise and there are signs of weaker spending, rates will come down sooner rather than later.
The bank’s other concern is the global outlook, where it expects a US slow down to be balanced by rapid growth in Asia and continued high commodity prices. The report says it will focus on whether the US housing slow down is spreading and whether Asia appears to remain robust. Any sign that emerging economies are vulnerable to slowing US import demand are likely to be crucial here for cutting rates faster.
Meanwhile, the bank report caused sterling to dip to a four-year low against the euro on Wednesday and gave up strong gains against the dollar and yen.The pound had dropped to $2.0650 against the dollar by midday Wednesday in New York, down 0.3 per cent on the session, and pulling back to Y230.00 against the yen.
The pound fell 0.9 per cent to £0.7113 against the euro, its weakest level since October 2003, as the currency was given a boost by figures showing eurozone growth accelerated by more than expected in the third quarter.
The euro also rose 0.7 per cent to $1.4690 against the dollar and climbed one per cent to Y163.60 against the yen.The yen suffered as higher equities encouraged investors back into carry trades.The Japanese currency fell 0.4 per cent to Y111.40 against the dollar, lost one per cent to Y100.44 against the Australian dollar and dropped 1.2 per cent to Y85.30 against the New Zealand dollar.