UK inflation remains above target

[August 17, 2010]  LONDON (AP) -- Inflation eased in Britain last month but remained well above the government's 2 percent target -- forcing the Bank of England to publish its third open letter this year to explain the extended blowout in prices.

The Office for National Statistics reported on Tuesday that the headline consumer price index rose 3.1 percent in the year to July, down from 3.2 percent in June.

That was the lowest rate since February, but the eighth consecutive month that the inflation rate has exceeded the target.

Bank of England Governor Mervyn King blamed one-time factors, including a rise in sales tax in January, alongside past rises in oil prices and the continued effects of higher import prices following the devaluation in the British pound since mid-2007.

King reiterated the bank's projections that inflation will remain above the target until the end of 2011 -- a year longer than it was predicting just a few months ago -- but would then fall back as the effects of higher sales tax, energy price rises and import price increases drop away.

King said last week that inflation was likely to fall back below target in 2012, but in Tuesday's letter to Treasury chief George Osborne he acknowledged that the recent strength in inflation had surprised the bank's rate-setting committee and "how fast and how far inflation will fall are both difficult to judge."

The Bank of England has maintained interest rates at a record low of 0.5 percent for 18 months despite concerns about high inflation as it plays the difficult game of balancing rising prices against a sputtering recovery from recession. Hiking rates could ease inflationary pressures, but that also risks undermining economic growth.

King said Tuesday that the committee stands "ready either to expand or to reduce the extent of monetary stimulus as the outlook demands," but most economists expect the benchmark interest rate to remain at the current level well into next year as inflation eases.

Andrew Goodwin, senior economic advisor to the Ernst & Young Item Club economic consultancy, said that the Russian wheat crisis and a further increase in sales tax next January would keep inflation hovering near 3 percent into next year.

"But these are all temporary factors and underlying price pressures remain weak -- once these temporary factors have fallen out of the calculation we are likely to see inflation settle well below the 2 percent target," Goodwin said.

In one supportive sign of that outlook, the statistics office reported that core inflation, which excludes more volatile elements such as the cost of energy, fell to 2.6 percent in the year to July from 3.1 percent.

The July inflation figures are closely watched as the retail index is used to set rail fare increases for the following year. That measure fell to 4.8 percent in the year to July from 5 percent in June.

Falling prices for petrol, clothing, footwear and furniture helped ease consumer price inflation, despite a 0.7 percent jump in food prices between June and July -- the biggest monthly rise for two years.

The Bank of England is required to write an open letter when inflation is more than 1 percent above or below the 2 percent target. It must write another letter if the rate remains out of that range three months later. King published letters in February and May this year.

[Associated Press; By JANE WARDELL]

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