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Inflation reaches 3.5%

UK inflation rose to 3.5% in January, up from 2.9% in December – its highest level since November 2008.

This large monthly movement is mainly due to the increase in January in the standard rate of VAT to 17.5% from 15%, and to a lesser extent the continued increase in oil prices.

It follows a record rise in the rate of inflation in December, when inflation surged to 2.9% from 1.9% in November.

January’s figure is well above the government’s 2% target and means Bank of England governor Mervyn King has written a letter of explanation to the chancellor.

In his letter to the chancellor, King says the direct effect of the short-run factors on inflation should be “only temporary”.

King says the committee has taken unprecedented action to ensure that the medium-term outlook for inflation remains consistent with the 2% target, this includes cutting the Bank Rate and its £200bn asset purchase programme.

Kings says: “It is important to emphasise that the effects of the money-financed asset purchases will persist. That, together with the low level of Bank Rate, will continue to provide a substantial boost to nominal spending for some time to come.

“The Committee is committed to taking whatever actions are necessary to ensure that the outlook is for inflation to remain in line with the 2% target.

“It will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”

The increase in the VAT rate in January 2010 had a significant impact on the change in the CPI annual inflation rate as it led to larger than normal price rises, or prices fell by less than usual, this year for a December to January period.

King warned last week that the UK would continue to “bump along the bottom” as inflation exceeds 3%, but said it would only be a temporary rise.

The Retail Prices Index annual inflation rate also increased again in January. The increase of 1.3% in the RPI annual inflation rate to 3.7% in January from 2.4% in December follows a 2.1% increase in the annual rate between November and December.

By far the largest upward contribution to the change in RPI annual inflation between December and January came from housing: in housing the largest upward effect to the change came from mortgage interest payments which rose this year but fell significantly a year ago when most lenders passed on at least part of the one point decrease when the Bank rate fell from 3.0%  to 2.0%.

There was also a significant upward effect from house depreciation, which rose this year but fell a year ago; this reflects movements in the Department of Communities and Local Government’s smoothed house price index that is used to calculate this component.

Partially offsetting these upward contributions was a small downward contribution from dwelling insurance where premiums rose this year but by less than a year ago.  



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