LONDON—U.K. consumer-price inflation accelerated sharply in December, underscoring the view that the Bank of England’s most likely next move will be to tighten policy, but the economy’s fragility suggests that action is a while off yet.
Data from the Office for National Statistics Tuesday showed annual inflation jumped to 3.7% last month from 3.3% in November, well above expectations as economists polled by Dow Jones Newswires had forecast a figure of 3.4%.
The latest figures amplify the dilemma faced by officials on the BOE’s Monetary Policy Committee, who must tread a difficult path between fostering economic recovery and keeping public inflation expectations under control.
"With the bulk of the government’s public spending cuts yet to be fully felt, many on the MPC will no doubt argue that more time is needed to assess the impact on the economy, before responding to high current inflation," said Rob Carnell, an economist at ING Bank. The U.K. government has promised £111 billion ($176.32 billion) of fiscal tightening by 2015. "Nonetheless, pressure on the doves to change their views is building."
The CPI annual rate has now been at least a percentage point above the BOE’s 2% target for a whole year. December’s rate was the joint strongest since November 2008.
In monthly terms, consumer prices rose 1% in December, well above the 0.4% rate in November and the largest increase since records began in 1996. Economists had forecast a 0.7% gain.
A U.K. Treasury spokeswoman defended the central bank, noting the influence of a series of temporary factors on the annual inflation rate. "Monetary policy is a matter for the Bank of England," the spokeswoman said. "As the bank has explained, the current levels of inflation reflect one-off impacts such as last year’s rise in [the sales tax] in January 2010, and rises in global commodity prices related to the fast-growing world economy."
Reflecting that view, the major factors behind December’s inflation pickup were greater transport costs, in particular fuels and lubricants, and the higher weighting of air fares, as well as housing and household services, due to the impact of gas prices on utility bills and liquid fuels prices, the ONS said. Petrol prices rose to a record high of 122 pence a liter in December. Food prices also gained 1.6% on a monthly basis and 5.7% annually.
The central bank’s core view is that the large amount of spare capacity in the U.K. economy will help drag inflation below target next year as one-off effects—including this January’s increase in the sales tax to 20% from 17.5%—subside.
But with inflation having been above the BOE’s target for 41 out of the past 50 months, and expected by many analysts to accelerate above 4% this spring, the concern is whether consumers will continue to believe the central bank when it says price rises are temporary.
A survey by Citi and pollsters YouGov earlier this month found that average inflation expectations for the year ahead were 3.5% in December, the highest since September 2008, while less-volatile longer-term expectations, for five to 10 years ahead, increased to 3.8% in December, the highest rate since May 2008.
Strong inflation expectations are a concern for central banks because they may encourage consumers to push for larger pay rises to compensate for high future inflation. This raises costs for firms, which in turn raise their prices—possibly leading to a vicious cycle.
"The probability of an interest-rate rise this year has certainly increased substantially in the past few weeks," said Hetal Mehta, U.K. economist at Daiwa Capital Markets Europe. But "until the economy is through what are likely to be the slowest quarters of growth this year—the first and second quarters—without lapsing into recession, the balance of opinion on the MPC is likely to remain in favour of keeping policy on hold."
In another ominous sign for the BOE, Tuesday’s data showed that core consumer-price inflation—which excludes volatile food, energy, alcohol and tobacco prices—also picked up in December, with recreation and culture a major driver. The core annual rate rose to 2.9%, compared with economists’ expectations for it to match November’s 2.7%. In monthly terms, prices rose 0.7%, up from 0.2%.
Annual retail-price inflation—traditionally used as a guide for pay settlements—rose to 4.8% in December from 4.7% in November, matching economists’ expectations. On a monthly basis, retail prices increased by 0.7%, up from a 0.4% gain in November, but slightly lower than forecasts for a 0.8% increase.
The BOE’s Monetary Policy Committee voted this month to keep bond purchases under its quantitative easing program at £200 billion and maintain its key interest rate at 0.5%. But opinion has been divided at recent meetings, illustrating the difficulty of the choices that the central bank faces, with MPC member Andrew Sentance calling for an immediate rate rise, and Adam Posen for more bond purchases.
In an interview published Tuesday, the BOE’s executive director for markets, Paul Fisher, said the central bank must set an interest rate that is appropriate to the medium-term outlook for the economy, rather than respond to short-term pickups in the inflation rate.
Speaking to the Yorkshire Post, Mr. Fisher acknowledged that the current rate of inflation is "very uncomfortable," but that he "wouldn’t want to go back and change policy."
"We have to look through those short-term things, despite whatever unpopularity comes our way, to try and set the best policy rates for the medium term," he said.
—Ainsley Thomson and Paul Hannon contributed to this article.
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