Inflation at highest for two years

Pressure on the Bank of England to raise interest rates has intensified as inflation increased to its highest level in more than two years in January.

The Consumer Prices Index (CPI) rose to 4% last month, from 3.7% in December, the Office for National Statistics (ONS) said, as the increase in VAT from 17.5% to 20% and the soaring cost of crude oil have pushed up the cost of living.

The CPI figure, the highest since November 2008, is double the Government’s 2% target and is likely to throw weight behind the argument for hiking interest rates from a historic low of 0.5%.

As inflation has been more than 1% above target for three months, it will trigger a letter of explanation from Bank of England Governor Mervyn King to Chancellor George Osborne.

The CPI rate unexpectedly surged from 3.3% to 3.7% in December, prompting calls for an interest rate hike. But weaker-than-expected economic growth figures, revealing a 0.5% decline in gross domestic product in the final quarter of 2010, dampened this prospect.

The economy is in a fragile position – teetering close to a period of so-called stagflation, when sluggish growth and high unemployment combine with soaring prices. Last week, the Bank held interest rates for the 23rd consecutive month.

Economists had expected inflation to hit 4.1% in January, so it has come in slightly below expectations. But the CPI rate of inflation rose 0.1% between December and January – the first time since records began in 1997 that inflation has risen between those two months.

The price of petrol as recorded by the CPI stood at £1.27 a litre in January 2011, a record high, the ONS said, while other contributing sectors included transport, restaurants and hotels, furniture and alcohol.

Downward pressure on overall inflation came from falling clothing prices, as well as a drop in the cost of recreational activities, such as CDs and DVD purchases.

The City will be looking closely at the Bank’s latest quarterly inflation report, published on Wednesday, to determine when policymakers believe inflation will start to return to the 2% target or if and when interest rates are likely to go up.