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Rate-setters left 'surprised' by strength of UK inflation, says Bank Governor; FIGURES REVEAL FALL TO 3.1% - WELL ABOVE 2% TARGET.

Byline: GRAHAM HENRY

BANK of England Governor Mervyn King yesterday claimed that rate-setters had been "surprised" by the stubborn strength of inflation in an open letter to Chancellor George Osborne.

Mr King also warned in the letter that it would be difficult to judge how far and fast it would fall.

His comments came after figures revealed that inflation had crept down from 3.2% to 3.1% in July, but remained well above the Bank's 2% target.

Falling petrol prices were effectively nullified over the course of the month by rising food costs on the Consumer Prices Index (CPI). The Bank has previously said that it expects inflation to remain above its target until the end of 2011.

Mr King said: "How fast and how far inflation will fall are both difficult to judge, with substantial risks in both directions."

The Bank of England was last week accused of being too optimistic in its forecasting over inflation, after being forced to lower its predictions for growth in its quarterly report.

The Governor added that the huge economic slack created by a record recession was being masked by January's VAT hike, high oil prices and sterling's weakness pushing up import prices.

He also underlined his warnings of a "muted" recovery not strong enough to close the gap created by the slump, eventually dragging inflation below the target.

But there was better news for the Bank's inflation-watchers after "core" CPI - which excludes volatile elements such as food, energy and alcohol prices - fell from 3.1% to 2.6%, the lowest level since November 2009. Stripping out the impact of indirect taxes such as VAT, CPI has slowed to just 1.4%.

Jonathan Loynes, chief European economist with Capital Economics, said: "The fact that core price pressures are clearly weakening for now should help to ease concerns that high inflation has somehow become ingrained in the economy or that the MPC is deliberately turning a blind eye to persistent price pressures.

He added that a majority of the Bank's rate-setting committee were "likely to remain comfortable" with record low interest rates to boost the economy for some time to come. Andrew Goodwin, senior economic adviser to the Ernst & Young ITEM Club, added: "Earnings growth remains below 2% and it is difficult to make a case for inflation taking off without a response from wages - in the current climate, with unemployment remaining high and public sector job losses on the way, the scope for workers to push up wages is very limited."

The Office for National Statistics figures showed a 0.7% jump in food prices between June and July - the biggest monthly rise for two years.

The annual rate of food inflation rose to 3% over the month - the highest for a year - while the Russian drought and rising wheat prices is set to build food inflation in the months ahead.

But falling petrol costs and second-hand car prices over the month dragged down the overall CPI, as motorists enjoyed an average 0.7p a litre drop over the month against a 1.1p hit at the forecourt a year earlier.

The squeeze on food shopping bills also contrasted with the picture on the high street, where retailers are still cutting prices in a bid to draw in worried consumers.

The ONS said clothing and footwear prices fell 4.9% between June and July, led by womenswear.

But rail commuters meanwhile will be braced for fare rises of almost 6% next January despite the Retail Prices Index (RPI) easing to 4.8% in July.

Most regulated rail fare increases are based on a formula of July's RPI plus 1% - which would leave passengers facing rises of 5.8%.

Andrew Tyrie, the Tory chairman of the Commons Treasury Select Committee, said the situation had to be monitored to ensure inflation did not become entrenched.

He told BBC Radio 4's The World at One: "What I think we have got to do is monitor this extremely carefully and bear in mind that we cannot afford to take risks with inflation while at the same time recognising monetary policy is very loose, it needs to stay loose.

"We have got interest rates at 0.5%, the Governor is making clear that they have got to stay there until we make sure that we have got a recovery deeply entrenched."
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Title Annotation:Business
Publication:Western Mail (Cardiff, Wales)
Date:Aug 18, 2010
Words:724
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