UK inflation surge casts doubt on rate cuts

LONDON - Soaring food and fuel bills sent British inflation rocketing in April, putting the prospect of interest rate cuts soon in real doubt despite further signs the housing market downturn is getting nasty.

By (Reuters)

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Published: Tue 13 May 2008, 8:41 PM

Last updated: Sun 5 Apr 2015, 1:34 PM

Inflation leapt half a percentage point to 3 percent, the biggest jump since 2002, leaving the rate way above the central bank's target of 2 percent, official data showed on Tuesday.

Bank of England Governor Mervyn King is now a tenth of a percentage point away from having to write to the government to explain how he plans to get prices back under control -- as required by law if inflation exceeds the target by more than a point.

Higher household bills are also creating a headache for embattled Prime Minister Gordon Brown whose popularity is slumping as Britons fret about the rising cost of living, tax rises and the falling value of their homes.

Finance minister Alistair Darling will address parliament at 1430 GMT to explain plans to compensate low-paid people who lost out when the government scrapped a 10 percent income tax band, a move which has proved particularly unpopular.

Sterling jumped half a cent and stocks fell as dealers marked down the chances of an interest rate cut next month. Most economists had thought this was pretty much a done deal as the economy is slowing because of a global credit crunch.

The housing market is suffering most. The Royal Institution of Chartered Surveyors' (RICS) house price survey on Tuesday posted its worst reading since it started 30 years ago.

"The dilemma facing the Monetary Policy Committee just keeps getting worse," said Michael Saunders, economist at Citigroup.

"On one side, the credit crunch and housing collapse threaten to slow consumer spending and the economy sharply ... on the other side, strong global cost pressures, the weak pound and surging inflation expectations threaten to produce an extended overshoot of the inflation target."

Markets are awaiting the BoE's quarterly forecasts on Wednesday. The central bank has cut borrowing costs three times since the credit crunch hit but the next move will depend on how much policymakers think slower growth will bring down inflation in the medium term.

3 percent or higher?

While soaring commodity prices around the world -- oil hit a record high on Monday -- suggest inflation could rise further, the latest data also showed some retailers cutting prices aggressively as they tried to cope with lacklustre demand.

One BoE policymaker -- arch-dove David Blanchflower -- has said worrying about inflation now is akin to fiddling when Rome burns, so worried is he about Britain's economic prospects.

Tuesday's RICS survey certainly painted a very bleak picture for the housing market where prices have started falling after years of double-digit growth as cash-strapped lenders make it harder for people to take out home loans.

Housebuilders are rattled. Redrow Plc and Gallford Try Plc both issued profit warnings on Tuesday. Many analysts are now predicting house prices could go down 10 percent this year.

That spells more bad news for the Labour government which is already on the ropes as the property market is a national obesssion and a proxy for consumer confidence in a country where two-thirds of homes are owner-occupied.

Brown's Cabinet discussed the economy and housing market for nearly an hour on Tuesday. The line for now is that the problems in the housing market are essentially a supply issue because of the freezing up of the mortgage market.

"It was therefore very different from the situation in the early 1990s, because the economy (then) went into recession and unemployment was very high," Brown's spokesman told reporters.

Still, the less scope the BoE has to cut interest rates, the harder it will be for the market to get back on its feet.

"A dramatic deterioration in inflation prospects during April may be forcing the Bank of England into a corner," said Matthew Sharratt, economist at Bank of America.

"The worse than expected inflation data in April now implies a serious risk that the next 25 basis point cut, that we had thought would come in June, may now be delayed until August."

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