Yahoo Finance What caused the shock inflation rise – and what it means for interest rates
Andrew Bailey and Jeremy Hunt faced an unwelcome surprise on Wednesday morning.
Inflation jumped for the first time in three months in February, with the Consumer Prices Index coming in at 10.4pc, official data showed.
Analysts had pencilled in a slight drop to 9.9pc, rather than an increase in the headline rate.
The shock increase was caused by another near record rise in food prices.
By one measure, the cost of food increased by 18.2pc in the year to February, which was the fastest rise since 1977.
Prices surged as bad weather led to vegetable shortages and empty shelves in supermarkets, pushing up the price of what produce was left in stock.
Meanwhile, restaurants and cafes also raised their prices at the fastest rate since 1991.
Does the inflation leap mean the Bank of England will increase interest rates?
The surprisingly high inflation numbers present a dilemma for the Bank of England, whose policymakers will decide on Thursday whether to raise interest rates again or not.
Rate setters, led by Governor Bailey, must weigh conflicting signals.
On the one hand, there are fears that further rate increases pose a risk to the banking system, following the recent collapse of banks in the US and the rescue of Credit Suisse in Europe.
On the other hand, a failure to keep increasing borrowing costs risks embedding inflation in the economy if price rises remain persistent.
For Hunt, the latest figures also present a problem. The Chancellor has made halving inflation this year one of his key pledges. Now, things are going in the wrong direction.
Rising prices will also add to the ammunition for public sector workers pushing for significant wage increases, putting more pressure on government finances.
What has caused the inflation rise?
The main driver of the surprise increase in inflation last month came from rising prices in restaurants and cafes, and for food and clothing, figures from the Office for National Statistics (ONS) showed.
Out of the 11 categories of food tracked by the ONS, eight rose in price between January and February.
The ONS linked this to shortages of salads and other vegetables after bad weather in southern Europe and Africa.
Higher electricity prices likely also hit unseasonal produce grown in greenhouses in the UK and northern Europe, the statistics body said.
The cost of vegetables has gone up by 18pc in a year, the highest level since 2009.
The price of bread and cereals, chocolate and confectionery, ready meals and hot drinks are also rising at the fastest pace since at least 2008.
British-grown tomatoes and other vegetables are expected to hit supermarkets at the end of this month, and Gabriella Dickens, of Pantheon Macroeconomics, said the vegetable shortages should ease soon.
When will UK inflation go down?
Yet there is disagreement about whether February’s unexpected rise will prove temporary.
Ruth Gregory, of Capital Economics, says: “The rebound we saw in core inflation was much stronger than anticipated. I think that was the most worrying.”
Core inflation strips away volatile components like gas and energy. It is closely watched by rate setters as it is seen as giving a clearer picture of the true inflationary forces at work in the economy.
The metric rose from 5.8pc in January to 6.2pc in February. It remains only slightly below levels seen in the final months of last year.
This could suggest that inflation remains rampant, even after the most aggressive cycle of interest rate rises since the Bank of England became independent.
“It does feel a little bit like the recent US experience where it did appear that core inflation was easing rapidly a few months ago only for it to reaccelerate again as economic activity proved resilient,” Gregory says.
In the US, core inflation initially peaked at 6.5pc in March last year. It then fell for a few months only to soar to 6.6pc again in September. It is currently hovering around 5.5pc.
Martin Beck, of the EY Item Club, is less concerned by the surprise inflation numbers on this side of the Atlantic.
“I think it’s a blip. Let’s not get too alarmed,” he says.
Soaring gas prices hit Britain particularly badly this time last year, which sent inflation soaring. The recent collapse in wholesale costs “should push down inflation faster in the UK than elsewhere,” he believes.
Dickens, of Pantheon Macroeconomics, agrees: “We think that's probably temporary. More broadly, the factors that are impacting inflation are pointing to it falling for the rest of the year.
“In April, on the anniversary of the big jumps in LNG prices last year, there will probably be similar falls this year.”
Rapidly falling gas prices have prompted several forecasters to predict the UK will avoid a recession this year.
Some, including Santander and Citigroup, also now expect inflation to fall back to or near the Bank of England’s 2pc target by the end of the year.
While the latest data puts a fly in the ointment, the unexpected rise in February may only slightly delay the timeline for inflation to return to target. Yael Selfin, of KPMG, says inflation is now likely to reach 2pc by the start of next year instead.
One month’s data should not be a cause for panic, she says, although it does complicate the Bank of England’s decision on whether to raise borrowing costs.
“It’s complicated because they still see that there may be a small risk that inflation is stickier,” she says.
“I think if I were on the Monetary Policy Committee I would probably make that additional rate [hike] and then pause to see where things are heading.”
Selfin is expecting the Bank to downshift to a 0.25 percentage point increase on Thursday, after back-to-back 0.5 percentage point increases.
While the recent turmoil in financial markets will make this decision more complex, it will also help inflation fall, she adds. Banks are expected to pull back from lending, taking some heat out of the economy.
“We have quite a lot of volatility now in credit markets anyway. They will likely be tighter,” Selfin says.
Falling gas prices, improving food supply and stricter lending mean the odds remain in the Bank of England and Jeremy Hunt’s favour.
Yet if February’s surprise figure is followed by another shocker for March, Threadneedle Street and Number 11 will surely start feeling more nervous.
