And that’s before the impact of January’s VAT rise, which the Bank itself has calculated could add another 1.4 percentage points. Roll on 5pc inflation.
Worse still, prices are rising on “non-discretionary” goods that households have little choice but to buy – fuel, gas bills, travel, food. By contrast, the downward pressure on inflation, according to the Office for National Statistics (ONS), is coming from furniture and furnishings. In other words, it would be a great time to refurbish the home if there was any money left in the kitty after feeding the family and getting to work.
The big question now is whether the Bank will react to rising inflation by lifting interest rates, which have been at a record 0.5pc low for the last 20 months. Inflation has been more than 1pc above target for 11 of the past 12 months, prompting four letters of explanation to the Chancellor. It’s getting embarrassing for Mervyn King, the Governor, but he’s in a bind. Raise rates now, just as the Government’s austerity measures start to kick in, and the recovery could stall.
Because the cost increases are on “non-discretionary” items, higher rates could push households over the edge. Two thirds of households are on variable mortgages, so they will feel the rise directly in their pockets. And, as wages are climbing at just 2pc, the effect of both rate rises and inflation will be to remove spending from the economy. The equation works in the same way for business, which is why the British Chambers of Commerce has this morning urged the Bank to stay its hand.
The Bank has evaded the issue in the past by arguing that inflation is being caused by one-off events. The same is true to a degree for December. Oil prices shot up and food prices were hit by poor harvests. There’s nothing the Bank can do to bring those costs down and, if anything, a rate rise would be counter-productive by piling misery on woe.
However, the ONS data also showed that core consumer prices inflation rose to 2.9pc from 2.7pc and that the driver of core goods inflation was services – in other words there is clear pressure on prices domestically, as well as externally. RPI, the figure traditionally used in wage settlements, also edged up from 4.7pc to 4.8pc – piling the pressure companies for larger pay rises, which will consequently fuel inflation. If inflation does start to spiral upwards, savings will be eroded and companies will struggle to borrow at affordable rates. Neither would be good for the country.
On balance, it looks increasingly likely that the Bank will raise rates sooner rather than later – perhaps as soon as next month. Some members of the rate-setting Monetary Policy Committee are prepared to move. Andrew Sentance has been voting for a small rise since June. And Paul Fisher told The Daily Telegraph last month: “I don’t think a change of 25 or even 50 basis points is going to trigger a recession.”
An early 0.25 percentage point rate rise to demonstrate that inflation won’t be tolerated will still leave rates at an historic low. If the move proves too much for the economy to bear, it can also be undone.
One thing is for sure, though. Early move or not, economists and the market alike now expect the Bank to raise rates more aggressively than before. The jump in sterling by 1pc against the dollar and the six point increase in 10-year gilt yields to 3.67pc following the inflation data today spoke volumes. If the economy demonstrates it can cope with austerity in the coming months, expect rate rises to come thick and fast. ABN Amro is now forecasting rates of 1.25pc by the end of the year. But the big moves are unlikely before the second half of the year, as moving too soon could prove devastating.
Whatever way you look, though, there is no escaping the message from the inflation data. Rate rises are coming, and households should prepare.
