Inflation jumps again – but Osborne tells King to keep rates low

Chancellor and Governor reaffirm 'medium-term' target

Inflation rose to a two-and-a-half-year high and well ahead of expectations in April, recording an official annual rate of 4.5 per cent, the Office for National Statistics said yesterday.

Prices rose 1 per cent between March and April, the joint highest one-month jump in the history of the Consumer Prices Index, going back to 1997. It represents an annualised rate of 12 per cent and underlines the continuing challenge stubborn inflation poses to policymakers.

On the older Retail Prices Index, inflation fell back slightly, from 5.3 per cent to 5.2 per cent, attributed to weighting differences between the two indices.

The Governor of the Bank of England, Mervyn King, wrote a further open letter of explanation to the Chancellor. Mr King has indicated that CPI inflation will peak at about 5 per cent later this year.

Nonetheless, the ONS pointed out that much of the increase is accounted for by special factors which ought to be reversed in subsequent months. A full 0.36 percentage points of the 0.5 per cent rise on March's rate of 4 per cent is accounted for by a record rise in the price of air, sea and rail tickets – but this is simply because the extended Easter break fell in April rather than March this year.

Traditionally, this is a time when transport companies take advantage

of heightened demand to ramp fares. The general expectation is that these price rises will be wound down in May, which should ameliorate the pressure on living standards. Overall, fares rose by 5.3 per cent on the month, and by 22.3 per cent on the year.

A second particular factor in April's figures is the hefty increase in duty and tax on alcohol and tobacco, accounting for another 0.12 percentage point of the rise. The Budget pushed the price of these indulgences up by 8.9 per cent on where they were a year ago – another CPI record.

Yet, despite such factors, underlying inflation is also looking threatening. Stripping out volatile factors such as food, alcohol and energy, underlying inflation stands at 3.7 per cent. The Bank of England has warned that gas prices may rise as much as 15 per cent in the second half of the year with electricity prices up 10 per cent. The Bank forecasts that inflation will not return to its 2 per cent target until 2013.

In his letter, Mr King said: "Three factors were largely to blame for the inflation overshoot – a rise in VAT in January and higher energy and import prices. Although the impact on inflation of these factors is difficult to quantify with precision, it is likely that had they not occurred, inflation would have been substantially lower and probably below the target."

In his reply, George Osborne stressed the "medium-term" nature of the inflation target and obliquely confirmed that the Bank's loose monetary policy is compensating for the severest fiscal squeeze on the economy since the Second World War. "I welcome the continued commitment to respond flexibly to the economic outlook and to set policy to balance the upside and downside risks to meet the inflation target in the medium term."

New boy at the MPC

Ben Broadbent, the latest addition to the Bank of England's Monetary Policy Committee, refused to be pigeon-holed as either a "hawk" or a "dove" yesterday. But his testimony to a Treasury Select Committee confirmation hearing very much gave the impression Mr Broadbent would not follow the lead of Andrew Sentance, the man he isreplacing at the MPC, as a campaigner for an interest rate rise.

Mr Broadbent, an economist at Goldman Sachs, said he agreed with the decisions taken by the majority of the MPC in recent months, which have been to leave rates on hold rather than raise them in line with Mr Sentance's vote.

"I think I would have followed pretty much what the bank has done," he told MPs on the committee. Mr Broadbent added that much of the recent rise in inflation had been driven by commodity price rises and higher taxes. And he said he saw little sign of inflation expectations rising significantly.