In a letter to Chancellor George Osborne explaining why inflation was double its target of two per cent in January, Bank of England Governor Mervyn King warns that inflation is likely to reach five per cent in the next few months, and that as a result, interest rates could rise three times to 1.25 per cent before 2012.
Official figures released yesterday show that inflation, measured by the consumer price index, climbed from 3.7 per cent in December to four per cent in January. This is the highest level of inflation for more than two years.
Explaining why inflation remains above target, Mervyn King wrote:
“Three factors can account for the current high level of inflation: the rise in VAT relative to a year ago, the continuing consequences of the fall in sterling in late 2007 and 2008, and recent increases in commodity prices, particularly energy prices.”
Although prices excluding the effects of these factors would put inflation at a rate “well below” the two per cent target, the reality is that inflation is likely to “pick up to somewhere between four per cent and five per cent over the next few months”, Mervyn King adds.
Mervyn’s Kings words have been picked up by economists as a sign that interest rates could rise three times to 1.25 per cent by the end of 2011.
Economists forecast that interest rates will rise by a first 0.25 percentage point increase by May, followed by another every three months for the next two years.