Mervyn King repeated his warning that the government’s measure of how fast prices are rising, the consumer prices index (CPI), could hit 5pc “over the next few months”, after figures showed it climbed 4pc in the year to January.
Nontheless, the UK’s foremost central banker said the Bank’s Monetary Policy Committee (MPC) thinks that trying to bring inflation back to the 2pc target quickly risks “undesirable volatility in output”. A hit to growth could even see the target undershot in the future, he said.
Mr King continued to blame the over-target inflation on “temporary effects”, citing the increase in VAT to 20pc at the start of the month, the fall in the pound and soaring commodity prices.
However, he warned: “There is a great deal of uncertainty about the medium-term outlook for inflation. And I do not wish to conceal that there are real differences of view within the committee, reflecting different judgements about the risks to that outlook.”
Mr King made the comments in his latest letter to the Chancellor after the Office for National Statistics (ONS) reported that higher oil prices and the recent VAT rise drove CPI inflation from 3.7pc in December to its highest point in more than two years.
The new rate – expected by economists signals that CPI inflation has been at least a percentage point above the Bank of England’s 2pc target since November 2009.
The retail prices index (RPI) gauge, which includes more housing costs and is the benchmark for many wage deals, rose from 4.8pc in December to 5.1pc, its highest since May.
“This is another kick in the teeth on the inflation front for the Bank of England albeit slightly less hard than some had feared” said Howard Archer UK economist at IHS Global Insight. “It maintains pressure on the Bank to retaliate by raising interest rates sooner rather than later.”
Alan Clarke, UK economist at BNP Paribas, said Mr King’s reference to division on the MPC over the inflation forecast suggested that another dissenter may have joined Martin Weale and Andrew Sentance at the last meeting in voting for a interest rates rise.
In response to Mr King’s letter Chancellor George Osborne said the Coalition’s austerity plan will give the MPC “the space it needs to target low inflation arguing that easing back on the pace of cuts would make the Bank’s job harder by adding to inflationary pressures. Read about the impacts of inflation on property investors in our inflation guide.
Economists generally expect the Bank to raise interest rates from their record low of 0.5pc late in the year but investors are betting that the inflation problem means a rise will come significantly earlier, arriving by May.
James Knightley of ING Bank, said all eyes are now on the Bank’s quarterly report published on Wednesday when it will update its forecasts for growth and prices.
“The general tone of the report and the accompanying press briefing will give us a much better idea as to whether the market fully pricing in a rate hike by May is realistic” he said.
On the latest figures the ONS said the biggest price rises were in areas such as fuel cars and eating out. In contrast clothing acted as a drag on the overal level of inflation as retailers cut prices in the January sales.
On the month CPI was up 0.1pc the first time it has risen between December and January since records began. CPI typically falls in January due to post-Christmas discounting.
Looking ahead the rate should keep rising as the oil price and the costs of other commodities climb further and companies continue to pass on the impact of the VAT rise to their customers.