Inflation is back….what now for interest rates?

Inflation is back with a bang. Now the question is what will happen to UK interest rates as prices rise at their fastest ever month-on-month pace?

The Office for National Statistics announced today that Consumer Price Index (CPI) inflation rose 1% last month, taking the annual rate up to 2.9% from 1.9% in November.

That was the biggest monthly rise in the annual index since records began and significantly worse than the City’s expectations for an increase to 2.6%.

Retail Price Index (RPI) inflation also rose to 2.4%, its highest level since November 2008.

This was a rise from 0.3% in November, and also constitutes the biggest monthly rise in the annual rate since 1979.

We all know borrowing rates are going up….but now maybe sooner rather than later!!! The analyst commentaries I have seen today point out that a large reason for the increase may be that 12 months earlier – when the recession first hit home – retail prices (including petrol) fell back generally. And those same analysts point out that whilst the return of 17.5% VAT on January 1st will feed through to further inflation increases for that month as well, there is still deflationary pressure in the economy through structural over supply. We shall see; maybe those “one-off” reasons and the nearness of an election may see interest rates stable for a while longer ….but surely the writing is on the wall?

The governor of the Bank of England is almost certainly going to have to write an open letter to the Chancellor if next month’s inflatiion figures are as high as anticipated; he will perhaps have a wider audience than is normal!

One key is going to be how effective employers – including crucially the public sector - are at fighting wage increase requests backed by inflation.