Mervyn King, the Governor of the Bank of England, is confident that inflation will fall back to the 2 per cent target in the medium term despite surging to 2.9 per cent in December, up from 1.9 per cent in November.
Speaking at the University of Exeter this evening, Mr King said that the rise in inflation, which is widely expected to rise above 3 per cent in January, was a temporary spike and that the growth in consumer prices would slow during the year.
The sharp rise in inflation is mostly down to events that occurred in December 2008, when the VAT rate was cut from 17.5 per cent to 15 per cent and oil prices fell sharply.
VAT remained unchanged last month, while oil prices rose, pushing up the headline rate of inflation.
He said: “I hope you will all remember that in both of the past two years inflation picked up as a result of temporary price level factors and then fell back, as the MPC had predicted.”
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But the City was less sanguine, taking the higher than expected inflation figures as further evidence that interest rate rises could be on the cards in the summer.
The March gilt future price settled 77 ticks lower at having earlier hit a session low of 114.19.
The ten-year gilt yield rose nine basis points to 4.03 per cent and the spread over similar-maturity bunds widened to 78 basis points, its widest since late 2007.
Howard Archer, chief economist at IHS Global Insight, said: “Looking at the longer-term inflation picture, Mr, King still appears confident that while inflation is headed above 3.0% in the near term and will be elevated over the first half of 2010, it will fall back thereafter to its 2.0% target level, provided that money supply growth remains under control.”
Inflation jumped by the biggest margin on record between November and December, official figures revealed today.
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The Consumer Prices Index (CPI) measure of inflation, the Bank of England’s preferred measure, soared to 2.9 per cent, up from 1.9 per cent in November, far higher than the expected increase to 2.6 per cent and well above the Bank of England’s target of 2 per cent.
It is widely expected that inflation will rise above 3 per cent this month, forcing Mr King to write a letter to the Chancellor to explain why inflation has risen by 1 per cent above the target.
This would be the sixth such letter since 2007.
Analysts attribute much of the rise in inflation to base factors filtering through from December 2008, when the VAT rate was cut to 15 per cent, as well as sharp falls in the price of oil.
VAT has been reset to 17.5 per cent.
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However, many observers expect that inflation will start to fall again after peaking this month, as does the Bank of England.
Hetal Mehta, senior economic adviser to the Ernst & Young ITEM Club, said: “Strong base effects are continuing to exert upward pressure on inflation.
“Today’s increase partly mirrors the sharp falls seen at the end of 2008 following the oil price spike and the impact of reduced VAT in December 2008.
“We do not anticipate any tightening of monetary policy to dampen this short-term phenomenon as, beyond January, inflation should continue on a downward path well into 2010.”
The main upward pressure on inflation came from the cost of fuel, which rose by 0.2 per cent between November and December, compared to a 6.2 per cent drop 12 months earlier.
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The price of clothing and footwear fell by smaller margins than in 2008, also helping to push up the overall rate of inflation.
The Retail Price Index (RPI) measure of inflation, which includes housing costs, such as mortgage payments, also soared, climbing to 2.4 per cent in December from 0.3 per cent in November, figures from the Office for National Statistics (ONS) showed.
Core CPI, which excludes food, energy, tobacco and alcohol, rose by 2.8 per cent on the year, its fastest pace of growth since records began in January 1997.