United Kingdom Inflation

United Kingdom

United Kingdom: Prices spike ahead of January's VAT increase

January 18, 2011

In December, consumer prices added one full percentage point over the previous month, which represented the sharpest price increase since 1993 and a record print for the November-December period. Moreover, the spike surprised market analysts, as it came in ahead of the January VAT increase in, and overshot market expectations of a 0.7% increase. The most important drivers behind December's spike were higher prices for transport (+3.6% month-on-month), in particular air transport fares (+41.8% mom). However, higher prices for housing and household services (+1.4% mom) along with higher food prices also contributed to the monthly rise. Owing to the strong price increase, annual inflation stepped up from 3.3% in November to 3.7%, well above the Bank of England's (BoE) 2.0% inflation target and exceeding the 1.0 percentage point tolerance margin. In fact, inflation exceeded the BoE's tolerance limit almost uninterruptedly throughout 2010, prompting the Bank's Governor, Mervyn King, to write four letters to the Chancellor of the Exchequer last year. In the latest letter, the Governor stated that inflation will likely remain elevated throughout 2011 amid higher commodity prices and January's VAT increase. The stronger-than-expected inflation result places additional pressure on the BoE to begin tightening its monetary policy despite the headwinds related to the fiscal consolidation programme. At its meeting on 13 January, the BoE left the Bank Rate unchanged at 0.50% and maintained the size of the asset purchase programme (quantitative easing) at the current GBP 200 billion, in a decision broadly expected by the market. The BoE projects inflation to exceed 3.0% until the second half of 2011.


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