U.K. Inflation Reaches 4.4%, More Than Double Target

By Svenja O'Donnell
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Aug. 12 (Bloomberg) -- U.K. inflation accelerated to more than double the central bank's 2 percent target in July, making it harder for policy makers to cut interest rates as the threat of a recession looms.

Consumer prices rose 4.4 percent from a year earlier, breaching the government's 3 percent upper limit for a third month and the most since comparable records began in 1997, the Office for National Statistics said today in London. That exceeds the 4.2 percent median forecast of 38 economists in a Bloomberg News survey.

House prices fell in July and retail sales dropped as Britain veered closer to a recession, reports showed today. Record oil and food costs have kept inflation above the target for 10 months, prompting Bank of England Governor Mervyn King and his colleagues to refrain from interest-rate reductions since April.

``The risk now is that inflation rises above 5 percent,'' James Knightley, an economist at ING Financial Markets in London, said in an interview on Bloomberg Television. ``There is a risk of a rate hike, but the weakness in activity suggests that they're more likely to stay on hold.''

Knightley predicted that the Bank of England will cut the benchmark interest rate ``quite aggressively'' next year from the current level of 5 percent.

Brown's Woes

The pound rose as much as 0.2 percent against the dollar after the report before erasing its gains and staying close to a 21-month low. The U.K. currency was at $1.9014 as of 10:25 a.m. in London compared with from $1.9108 yesterday. It was at 78.43 pence per euro compared with 78.03 pence.

Rising living costs are deepening the unpopularity of Prime Minister Gordon Brown, whose governing Labour Party trails behind the opposition Conservative Party by 20 percentage points, according to a YouGov Plc survey published on Aug. 10.

Consumer-price increases are also accelerating in the euro region, where the inflation rate rose to 4.1 percent in July, the highest since April 1992 and more than double the European Central Bank's ceiling of 2 percent.

The U.K. inflation rate jumped from 3.8 percent in June. The 0.6 percentage point increase was the biggest since the series began in 1997. Based on a constructed index using retail- price data, it was the largest gain since 1991, the statistics office said.

King will have to write his third letter of explanation to the government unless inflation slows to 3 percent in August, which would require an unprecedented drop in consumer prices.

Letter of Explanation

The letter, setting out how he would return inflation to target, is required under rules established when the bank won rate-setting independence in 1997.

Consumer prices stayed unchanged on the month in July. The inflation rate jumped after the cost of food and non-alcoholic drinks rose 12.3 percent from a year earlier, the most on record, and energy prices increased, the statistics office said.

Oil prices have dropped 19 percent since reaching a record above $147 a barrel on July 11. They are still more than 60 percent higher than a year ago. Producer prices increased in July at the fastest pace since records began in 1986, the statistics office said yesterday.

So-called core inflation, which strips out costs of food, energy, tobacco and alcoholic beverages, accelerated to 1.9 percent in July, the most since June 2007.

Pay Pressure

Retail-price inflation, which pay negotiators use as a measure of the cost of living, quickened to 5 percent, the fastest pace since 1991. Excluding mortgage-interest payments, it reached 5.3 percent, the most since 1992, today's report showed.

Faster inflation has yet to stoke pay pressures. Wage data due tomorrow will probably show salaries including bonuses increased 3.6 percent in the second quarter, the weakest pace in almost a year, according to the median of 30 forecasts.

Slowing economic expansion may curb inflation. The International Monetary Fund last week slashed its forecasts for U.K. growth to 1.4 percent this year and 1.1 percent in 2009. The economy expanded 3 percent in 2007.

House prices fell in July as the squeeze on credit locked out buyers and brought the property market to a ``virtual standstill,'' the Royal Institution of Chartered Surveyors said today. Sales in shops open at least a year fell an annual 0.9 percent, the British Retail Consortium said in a separate report.

Slowing economic growth has pushed up unemployment. Claims for jobless benefits probably climbed for a sixth month, increasing 17,000 from June, according to the median forecast of 31 economists in a Bloomberg News survey. The Office for National Statistics will publish the figures tomorrow.

The Bank of England predicted on May 14 that growth will slow to a 1 percent annual pace in the first quarter of 2009, the weakest since 1992. King said then that there may be ``an odd quarter or two of negative growth,'' while predicting inflation would quicken to more than 4 percent. The bank will release new forecasts tomorrow.

To contact the reporter on this story: Svenja O'Donnell in London at sodonnell@bloomberg.net.