MPC urged to cut rates despite rising trend for inflation

Inflation rebounded sharply last month from June's record low, depressing hopes that the Bank of England may cut borrowing costs soon to shore up Britain's tentative economic recovery.

The office for national statistics said seasonal food prices and household goods had been the most important drivers behind a rise in the annual rate of underlying inflation to 2% in July, up from 1.5% the previous month.

Union leaders urged the Bank's monetary policy committee not to use the figures as an excuse to postpone a confidence boosting rate cut. "Regardless of the slight rise in inflation reported today, we will be pressing the Bank to cut interest rates at its September meeting," said the TUC general secretary, John Monks. "Monetary policy needs to focus on the stagnating world economy and UK manufacturing heading back into recession, dragging the rest of the UK economy with it."

Shallower discounting in this year's summer sales and smaller falls in seasonal food prices caused most of the rise in the annual rate between June and July. Seasonal food prices dropped 0.9% in the month, a much lower fall than a year ago, with the result that food prices contributed less downward pressure on the overall index.

The statistics office said sales on the high street had started earlier than usual as retailers sought to take advantage of June's extra bank holiday, which could explain why discounting in July was not as deep as last year.

There was also an upward effect from motoring costs as little change in vehicle tax and insurance in July contrasted with falls a year ago while petrol prices fell by less than last year.

"Rather than signalling the start of a massive inflation surge, this jump in July's infla tion rate simply proves that last month's sharp fall was largely due to temporary factors," said John Butler, UK economist at HSBC markets.

Some analysts said the rise in inflation from its record low made it unlikely that the Bank would cut interest rates in the next few months from the 38-year low of 4%.

"July's outturn of 2% year-on-year takes us back above June's 1.5% but, more significantly, takes us back above May's 1.8%, on which basis it is more than just unwinding June and underpins the rates-on-hold view," said Geoffrey Dicks from the Royal Bank of Scotland.

Goods prices fell 0.9% year on year, the third month in a row that the sector has been in deflation. In the service sector prices rose 4.5% year on year.

The jump in the underlying rate will come as no surprise to the MPC which predicted last week that inflation would pick up from June's record low. In its quarterly inflation report last week the Bank predicted inflation would remain below the government's 2.5% target for most of the next two years.

With inflation at very low levels, several analysts said the Bank had room to cut rates if the economy weakens further. "Unless we see a significant improvement in the outlook for the world economy, we still expect the Bank to ease rates by 0.25 percentage points in the fourth quarter," said David Page, UK economist at Investec.

Yesterday's rebound in the underlying rate should spare Sir Eddie George from the embarrassing task of writing a letter to the chancellor, Gordon Brown, explaining why the Bank has missed its target. Threadneedle Street's remit is to keep inflation at 2.5% and if the annual rate veers one percentage point above or below that level, Sir Eddie must explain why in writing.