The Consumer Price Index (CPI) jumped to 3.7% in December from 3.3% in November, at the same time the Retail Price Index (RPI) rose by a more modest 0.1% to 4.8%. CPI includes mortgage interest payments, RPI does not.
The rise is more than the Bank of England and most economists were expecting.
The Office for National Statistics (ONS) who produce the inflation figures attributed the rise to higher aviation and petrol prices. Increasing food prices also played a significant part in the rise, with food inflation showing the highest ever recorded rise for the month of December.
The rise in CPI will come as a shock to many and is a real headache for the Bank of England. CPI is now nearly double their 2% target and the Bank’s view that the recent rises are a temporary spike are looking less credible with each passing month.
So, is this just a temporary spike or part of a longer term upward trend?
The Bank of England believe that recent rises are in fact just a spike and that once the government’s austerity measures fully bite we will see inflation fall back closer to target.
Many economists share this view, although today’s figures will put more pressure on the Bank to push up interest rates sooner rather than later.
Alan Clarke, economist at BNP Paribas commented: “The question is whether the peak is 4.1, or is it higher?”. He added: “It confirms my suspicion that the first rate hike will come this year; the only question is how soon”.
It should also be remembered that today’s rise will not take into account the recent rise in VAT, the effects of which will only become apparent over the next few months.
How does rising inflation affect me?
Simply put, the cost of living is getting more expensive. This, coupled with below inflation wage rises will squeeze household budgets as the year progresses.
Further pressure will be added if interest rates and consequently mortgage repayments also rise.
Increasing inflation also causes problems for savers. Whilst inflation is rising and interest rates remain at historically low levels getting a real, after tax return, for savers is hard.
So, will interest rates rise?
This is the $64,000 dollar question.
Whilst inflation remains above target The Bank of England has a delicate balancing act to perform. Businesses and mortgage holders will be quite happy for rates to remain unchanged and will hope that The Bank is right in its assessment of the recent rises. However, savers, who are seeing the real value of their money eroded, would in general, welcome a rate rise sooner rather than later.
The best case scenario is that The Bank is correct in its view that these recent rises are just a spike and that inflation will fall back, closer to the 2% target, later in 2011 and towards 2012.
Only time will tell.