Money Story

04 July 2009 12:07 BST

Inflation hits 4.7 per cent

Bank of England governor Mervyn King has told the chancellor of the exchequer inflation is expected to peak soon at five per cent.

However, inflation is likely to remain above target well into 2009, Mr King warned in his letter to Alistair Darling, explaining why inflation is above the two-per cent target again.

A depreciation in the value of sterling has added to inflationary pressures from rises in global oil and food prices, Mr King said. This will lead to more letters into next year.

Inflation expectations have also risen to record highs recently, which may make companies feel more confident in passing on price increases, pushing inflation ever higher.

This means a period of "muted economic growth" is necessary to bring inflation back down, although the central bank is wary that a severe fall in economic growth could lead to inflation falling below the two per cent target when it starts to fall.

Inflation hit 4.7 per cent in August on a sharp rise in household energy bills, according to the Office for National Statistics.

The increase was larger than expected, up from 4.4 per cent in July, and the highest since April 1992.

British Gas and EDF both increased their tariffs in late July, contributing to the rise in the consumer price index (CPI), a measure of inflation used by the Bank of England's monetary policy committee (MPC) to set the interest base rate.

Capital Economics analyst, Jonathan Loynes, said: "August's UK CPI figures suggest that the MPC's inflation worries are unlikely to evaporate completely for a little while yet.

"Nonetheless, the recent sharp falls in oil prices mean that Mervyn King will predict in his letter to the Chancellor – to be published at 10:30 BST – that headline inflation will peak in the next month or two and should drop back sharply over the next year as energy effects fade."

But Howard Archer from Global Insight warned: "Consumer price inflation is set to go higher still over the next couple of months despite the recent substantial retreat in oil prices.

"Indeed, consumer price inflation seems likely to reach five per cent as sharply rising utility bills, elevated food prices and a weaker pound impact."

Mr Archer also believes the Bank of England will start cutting interest rates soon despite inflation, as the recent market turmoil may worsen the credit crunch.