King Obliged to Explain Inflation Plan as Rate Exceeds 3% for Fifth Month

By Jennifer Ryan - Aug 17, 2010 1:02 PM GMT+0400

U.K. inflation held above the government’s 3 percent limit in July, forcing Bank of England Governor Mervyn King to write his third public letter this year to explain how he will bring prices under control.

Consumer prices rose 3.1 percent from a year earlier, compared with a 3.2 percent increase in June, the Office for National Statistics said today in London. The result matched the median forecast of 31 economists in a Bloomberg News survey. The bank will publish King’s letter to finance minister George Osborne at 10:30 a.m. today in London.

King predicted last week that inflation will slow below the 2 percent target next year as the government’s budget squeeze constrains growth. Today’s reading may harden a divide on the Monetary Policy Committee, where policy maker Andrew Sentance has argued for an interest-rate increase to tame consumer prices while other officials have warned more stimulus may be needed.

“There are a few things that have been out of their hands that have caused inflation to surprise on the upside,” George Buckley, chief U.K. economist at Deutsche Bank AG in London, said in a telephone interview. “The Bank of England is still credible, it will keep inflation at target over the long run. The bigger question is what combination of interest rates and policy that means.”

The pound was little changed after the report at $1.5657 as of 9:59 a.m. in London. The yield on the benchmark two-year government bond rose 4 basis points to 0.685 percentage point.

Baking Ingredients

Inflation slowed because of lower costs of transport, clothing and footwear, and miscellaneous items such as financial services, the statistics office said. The rate stayed higher because transport and food costs remained more elevated than a year earlier.

Newcastle, England-based Greggs Plc, the U.K.’s biggest baker, said August 10 the higher price of wheat has pushed up ingredient costs, though it isn’t planning to increase the prices of its products yet. First-half profit rose 13 percent as it offered meal deals to attract customers who had less disposable income than a year ago.

Under U.K. law, the Bank of England governor must write a letter to the chancellor of the exchequer every three months when inflation exceeds the 3 percent upper limit. King already sent explanations to the Treasury in February and May.

Core inflation, which excludes the cost of food, tobacco, alcohol and energy prices, slowed to 2.6 percent from 3.1 percent in June. Economists forecast a reading of 3 percent according to the median of 9 predictions in a Bloomberg survey.

Inflation Deviation

The inflation rate has held above the government ceiling since March as the weaker pound and higher commodity costs feed price pressures in the economy. Sterling has fallen by about a quarter on a trade-weighted basis since the start of 2007 while oil prices have more than doubled in the last 18 months. Wheat prices have surged 44 percent in the past year.

The bank’s inflation projections show the rate will be higher next year than it had previously forecast after Osborne raises sales tax to 20 percent in January from the current 17.5 percent. The higher levy will accompany the biggest round of budget cuts since World War Two to tackle a record deficit. The bank predicts inflation will then slow below 1.5 percent.

Policy makers held the key interest rate at a record low of 0.5 percent this month and their bond-purchase plan at 200 billion pounds ($313 billion). The bank will publish minutes of the decision tomorrow. Sentance argued in June and July that the benchmark interest rate should be raised to control inflation.

King said last week the overall outlook for the economy is weaker than in May, and “if it is necessary to respond, then we are quite prepared to do that.”

Retail price inflation, a measure of the cost of living used in wage negotiations, slowed to 4.8 percent from 5 percent in June. The result was exactly the same for the rate excluding mortgage-interest payments.

To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net.