UK inflation rate rises to 4% in January

Bank of England building The Bank of England will now have to explain how it aims to tackle inflation

The UK Consumer Prices Index (CPI) annual inflation rate rose to 4% in January, up from 3.7% in December, as the effects of the VAT rise were felt.

Higher oil prices also meant inflation remained well above the 2% target.

Retail Prices Index (RPI) inflation - which includes mortgage interest payments - rose to 5.1% from 4.8%.

The CPI figure is the highest since November 2008, and will put pressure on the Bank of England to lift interest rates to curb accelerating inflation.

The CPI measure has now been one percentage point or more above target for 14 months.

Bank of England governor Mervyn King has now written to the government, after sending three such letters last year, explaining the outlook for inflation and what will be done to tackle it.

In his letter he says inflation is likely to rise towards 5% in the coming months.

Referring to expected interest rate increases, he added: "The MPC's central judgement, under the assumption that Bank rate increases in line with market expectations, remains that inflation will fall back so that it is about as likely to be above the target as below it two to three years ahead."

UK inflation

Mr King said the rise in inflation was due to the VAT rise, the past weakness of the pound and recent rises in commodity prices.

"In his view, the 4% rise in the CPI in the past 12 months is unfortunate - but temporary, and almost entirely driven by factors beyond the Bank's control," said the BBC's economics editor Stephanie Flanders.

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There are those who wonder whether all of the most recent price rises can necessarily be blamed on outside factors”

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"Until this month, I would say that the majority of City experts have agreed with him that most of the upward pressure comes from the fall in the pound, VAT changes, and global changes in the price of food, energy and other commodities.

"But there are some warning flags in the January numbers."

In his reply to Mr King's letter, Chancellor George Osborne said he recognised that commodity prices had been "a key driver of recent UK inflation". However, there was no reference to the recent VAT increase.

Shadow chancellor Ed Balls, speaking on BBC Radio 5 live, blamed inflation on the VAT rise, which he described as "a mistake".

'Main factors'

The price of petrol as measured by the CPI was £1.27 a litre in January 2011, which the Office for National Statistics said was a record high.

Other contributing factors included rising costs of transport, restaurants and hotels, furniture and alcohol.

The monthly figures are the first to include the effects of the rise in VAT from 17.5% to 20%, which took place on 4 January.

"Two of the main factors that had an impact on the January data are the increase in the standard rate of Value Added Tax (VAT) to 20% and the continued increase in the price of crude oil," the ONS said in a statement.

'Mistake'

Barber: 'There's real pressure to try and see pay rises that at least protect people's standard of living'

The British Chambers of Commerce believes that inflation will rise to 4.5% before it stabilises.

And it warns that although interest rates will probably have to rise later this year, the MPC should wait until the impact of the government's cost-cutting austerity measures are fully in place.

"Considering an increase in interest rates before the middle of the year would be a mistake," said BCC chief economist David Kern.

But Alan Clarke, economist at BNP Paribas, says the base rate may now rise in the coming months.

"My own view is that it will be just after the summer, but increasingly it's looking more likely it could happen sooner rather than later - maybe as soon as May," he said.

Meanwhile, Saga, a firm focused on serving the over-50s, called for an increase in interest rates "sooner rather than later".

It pointed out that older people often live on fixed incomes and rely on their savings for additional income.

Savings returns have declined as interest rates have remained at 0.5%.

Economy shrinks

The CPI rate rose 0.1% on a monthly basis between December and January - the first time since records began in 1997 that inflation has risen between those two months.

George Osborne: 'Clearly inflation is a challenge and what this means is higher prices for families when they fill up at the petrol pump'

The CPI figure usually falls in January in the wake of prices being slashed in the January sales.

Until now, the Bank of England has been confident that the pick-up in the inflation rate is temporary, with no need for an interest rate increase in the near term.

Last week, the Bank held interest rates at a historic low of 0.5% for the 23rd consecutive month.

The last set of UK growth figures showed that the economy contracted by 0.5% in the final quarter of 2010, which weakened calls for a rate rise.

Target overshot

More economic data being released this week, including the Bank's inflation report on Wednesday, jobs figures the same day, and retail sales figures on Friday, will be closely watched.

"The [inflation] numbers are broadly in line with market expectations, but the issue for the MPC is that inflation has overshot its target for much of the last five years and many are doubting its commitment to the inflation target," said Amit Kara, at UBS.

"Under these circumstances the committee has no choice but to sound hawkish at tomorrow's inflation report.

"We're looking for a [third quarter] rate hike but if the economic growth surveys remain good, that could be brought forward."

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