15th February 2011

F&C: Ted Scott comments on UK Consumer Prices Index

The Bank of England received further bad news today as the reported CPI rose to 4% for January, up from 3.7% in December. It is the highest number since November 2008. This was in line with expectations but some analysts were anticipating an even worse figure following several months when inflation data had overshot consensus. In addition, core inflation rose again to 3% (much higher than the US where it is less than 1%) and the RPI increased from 4.8% to 5.1%.

There will now be increased pressure on the MPC to increase interest rates from the 0.5% level it has been at for a record 23 months. The Governor is likely to argue, in his now regular monthly letter to the Chancellor, that the rise is mainly due to external factors outside its control. These include the increase in VAT to 20% at the beginning of the year, higher energy costs with the price of oil rising to over $100 per barrel and, especially, the recent rise in food prices reflecting the spike in soft commodity prices.

The Bank of England’s monthly inflation report is to be published tomorrow that will reveal more of the committee’s reasoning and the MPC is also likely to argue that there is still a lot of spare capacity in the economy and the threat of rising wage pressures remains muted. It will also not want to jeopardise the recovery with the full effects of the spending cuts only just beginning to be felt.

However, the mandate of the Bank is to target a 2% inflation rate "at all times" and with the inflation rate now having risen to double that level its credibility is being undermined and it is increasingly perceived as neglecting its duties. What is crucial is that inflationary expectations are contained because if they start to rise they will quickly become entrenched and they will be difficult to reverse. In this respect the initial reaction was encouraging with sterling and gilt yields falling slightly in response to the news. To continue to contain inflationary expectations the MPC needs to more effectively communicate its anti-inflationary strategy and the report tomorrow would be a good starting point.

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