Inflation rise dents hopes of rate cut

Pre-Christmas price increases by furniture retailers caused an unexpected blip in inflation last month, denting hopes of more cuts to the cost of borrowing, figures revealed yesterday. While the headline rate of inflation in the 12 months to December fell from 3 per cent to 2.8 per cent, the underlying rate, which the Government uses to measure price pressures, rose by 0.1 percentage points to 2.6 per cent, according to the Office for National Statistics. The Treasury has set a target of keeping underlying inflation at 2.5 per cent.

The figures mark the first time in five months that the Bank has missed its target. The underlying rate excludes mortgage interest payments, which have fallen sharply since the Bank started cutting base rates in October.

"The slight increase in the underlying rate was unexpected, and coupled with the recent fall in unemployment, could make the Monetary Policy Committee more cautious about cutting interest rates further," said Francesca Massone from Goldman Sachs. The increase was largely caused by higher prices for seasonal vegetables and a sharp rise in household goods inflation, the ONS said.

The cost of household goods rose by 2.5 per cent over the month as retailers bumped up prices to exaggerate the size of the discounts in the January sales. The figures surprised economists after widespread reports that shops had started sales early to tempt reluctant shoppers.

The Confederation of British Industy renewed its calls for further cuts to base rates, despite the news on inflation. "We expect inflation to move below the Government's target through 1999 given sluggish growth forecasts and continued downward price pressure evident in the manufacturing sector," said Kate Barker, the CBI's chief economic adviser. "We still believe that interest rates should be reduced towards 5 per cent by the spring.'There was more bad news in separate figures from the Treasury, showing that public sector borrowing was higher than expected in December. The cash requirement was ?3.17 billion in December, against market expectations of between zero and ?0.8 billion. However, much of the increase resulted from changes in the timing of interest payments on Government bonds.

Cumulative borrowing for the financial year, on this measure, stands at ?3.2 billion compared with ?10.6 billion in the 1997 fiscal year.

The Chancellor, Gordon Brown, yesterday quashed speculation that the Government would ditch the current measure of inflation in favour of the move to the European harmonised index in the Budget, believed to be scheduled for March 9.