May CPI triggers BoE letter to Chancellor
17 June 2008
British consumer price inflation exceeded expectations in May, reaching its highest level since the Bank of England was made independent in 1997. The Office for National Statistics confirmed CPI rose 0.6% last month from April, dragging the annual rate of inflation to 3.3% from 3.0%. Mervyn King, the Bank's Governor, is now required to write an open letter to the Chancellor after CPI surpassed the Bank’s target rate of 2% by a full percentage point. The letter should explain why inflation has intensified and what the Bank is doing to address it.
The last time the Bank was forced to explain itself was in April last year after inflation for the previous month spiked to 3.1%. Then only one letter was required as price pressures subsided quickly. This time around, the Bank of England has forecast inflationary pressures are likely to persist, peaking near 4.0% in the second half of the year before subsiding thereafter. Recent inflation indicators have made for grim reading. Factory gate inflation hit a record high of nearly 9% last month, firms' costs surged at their fastest rate in at least 22 years and Britons' expectations of future inflation also hit a series high.
The spike in consumer prices is likely to cement expectations of higher interest rates in the months ahead. However, it is important to remember that the Central Bank base their monetary policy direction on a two-year inflation horizon and the Bank had already factored in similar movements of CPI in their May Quarterly Inflation Report. Sterling initially rose to a one-week high against the Dollar before reversing to hit a session low. The market has become increasingly aware of the deteriorating situation in the UK economy, incorporating higher inflation and slowing growth, prompting a sell-off in the Pound.