UK CPI inflation holds steady at 4.5%

Michelle Harrison from TNS explains how people's shopping habits have changed

UK Consumer Prices Index inflation held steady at 4.5% in May, new data shows.

It means the CPI rate has now overshot the Bank of England's 2% target for 34 of the past 40 months.

The Retail Prices Index (RPI) measure of inflation - which includes mortgage interest payments - was also unchanged at 5.2%, according to the Office for National Statistics (ONS).

But analysts said rising energy prices meant inflation was likely to resume its upward path in the coming months.

"With the announcement of higher utility prices coming through by the summer, there's a good chance we'll be looking at a 5% plus inflation rate by the autumn," said Peter Dixon at Commerzbank.

Fuel and food prices continued to be the main contributors, with both components up 1.3% from April.

Air and sea transport costs fell sharply in May, but not enough to fully reverse an even sharper jump in costs in April for the Easter break.

Over the course of the past 12 months, transport costs remain the biggest contributor to inflation.

Meanwhile, alcoholic drinks and tobacco have now recorded a 9.8% increase since last year - the highest year-on-year rise on record - thanks in part to the VAT rise.

Fuel prices also accelerated, up 13.7% compared with a year ago.

Bank resistance

The overall inflation figure was in line with market expectations.

It follows a rise to 4.5% in April - the highest inflation rate since October 2008 - from 4% in March.

Chart showing component contributions to the 12-month inflation rate

The Bank of England expects CPI inflation to rise above 5% in the next three months, well above its 2% target, and analysts are also expecting the rate to increase.

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Neither the Bank of England nor any City commentator expects inflation to fall in the next six months”

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"Not only did transport inflation - airfares in particular - not fall all the way back after last month's Easter-related jump, but food price inflation also rose a bit more sharply than we had expected," said Jonathan Loynes of Capital Economics.

"Further rises in the latter, along with recently announced further energy price hikes, are likely to take the headline inflation rate above 5% perhaps, and perhaps even above 5.5%."

Last week, Scottish Power - which supplies 2.4 million UK households - said it would increase the cost of gas by 19% and the cost of electricity by 10% from 1 August.

The Bank of England has resisted calls to raise interest rates - seen as the most effective policy tool in combating inflation - on the basis that temporary, external factors, such as rising oil and food costs, are driving price rises.

It believes raising rates could undermine the UK's fragile economic recovery.

Rate move

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Jenni Ruegg

I try to keep my husband well fed. I will have less. I've been hungry, I've gone to bed crying because I've been hungry. There are bad weeks and good weeks, but I just keep going”

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Most economists agree with the Bank that inflation will fall back sharply next year, when the effect of the VAT increase drops out of the data and household energy bills are expected to stabilise.

And the Bank will have noted that core inflation fell back to 3.3% from the record high of 3.7% set in April.

Core inflation strips out volatile food and fuel prices, and is closely watched by the Bank as a signal for longer term inflation trends.

Earlier this month the Bank held rates at a record low of 0.5% for the 27th month in a row.

The Bank is widely expected to hold off raising rates until after the summer, and perhaps even until 2012 - a view reinforced by the latest data.

However, for the previous four months, three members of the Bank's rate-setting Monetary Policy Committee have voted to increase rates.

Savers' pain

People on low incomes have suffered higher inflation than those on higher incomes in the past decade, according to a study released on Tuesday by the Institute for Fiscal Studies.

The IFS said the difference in fortunes had been particularly marked since 2008, and pensioners on state benefits had been especially hard hit.

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Mandy Snelling

When you retire, you think you have put enough aside to see you through”

End Quote Mandy Snelling Knit and Natter group member

People on lower incomes spend a higher proportion of their money on gas, electricity and food, the cost of which has risen sharply, while those on higher incomes have benefited more from lower mortgage rates.

"Many workers have had no pay increase this year and even those who have are finding their household budgets stretched to breaking point, as prices rise twice as fast as pay," said Brendan Barber, general secretary of the TUC.

"But raising interest rates now would only make matters worse."

Among those hardest hit by the continuing high rate of inflation are savers.

The effect of inflation on savings means that £10,000 invested five years ago, allowing for average interest, inflation and tax at 20% would have the spending power of just £9,441 today, according to financial information service Moneyfacts.

"Rising inflation means hundreds of thousands of savers need accounts paying a staggering 5.63% before they earn a real rate of return on their savings," said Sylvia Waycot from financial information service Moneyfacts.

"This is going to be pretty difficult bearing in mind the average interest offered on an easy access savings account is 0.89%."

Basic rate taxpayers have just one account, a fixed rate Isa, which negates the effects of CPI inflation, according to Moneyfacts. There are no fixed rate accounts available for any taxpayer that beats RPI inflation.

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