Why the latest inflation figures will rattle the Bank of England

Britain’s inflation problem just isn’t going away. In fact, it might be getting worse. Expect the debates in the Bank of England’s rate-setting meetings to get an awful lot more vigorous over the next few months. Here’s why.

At first glance, there doesn’t seem too much to worry about. The UK’s headline CPI (consumer price index) rose by 0.1% last month. And the year-on-year rate dropped to 3.2% from 3.4%. That’s still way above the 2% target, but at least it’s heading in the right direction.

But that’s where the good news ends. The old retail price measure (RPI) is still climbing at 5% annually.

And here’s the really nasty bit. ‘Core’ inflation – the red line on the chart below – which strips out the nasty volatile bits like most food and energy prices, has now moved back to its recent high of 3.1% a year.

The damage this time has been done by service sector prices rising at a worrying 3.9% annual clip.

Source: Bloomberg

Meanwhile the Bank of England has been holding base rates – the blue line – at a record low 0.5%.

So the big question is: how long before these get hiked?

Yes, I know that UK interest rate policy isn’t set by core inflation. And – officially – the Bank reckons that CPI will gradually fall below target. But it’s been consistently wrong about inflation, saying prices would rise much less quickly than the eventual outcome.

And within the last month, three members of the Bank’s rate-setting Monetary Policy Committee have expressed concern that our inflation rate is a bigger threat than had been thought. Meanwhile the Bank of International Settlements has been warning us of the inflationary dangers of ultra-low rates.

Yes, nearly all economists agree there’s almost no chance of a UK base rate hike this year, particularly if the economy nose-dives again. And from the government’s point of view, the whole point of fiscal austerity is so that rates can stay low.

But when all the economists concur, I get worried that the opposite could be about to happen. If the strengthening pound and a fresh dose of jitters about global growth don’t start to translate into falling prices for British consumers, the Bank is going to come under a lot of pressure. Keep a close eye on that core rate.