Government braced for rate rise

The government was softening up the public today for an increase in interest rates after soaring gas and electricity bills pushed the annual rate of inflation to its highest level since Labour arrived in office more than nine years ago.
With prices for domestic energy rising by almost 30% in the past year, the cost of living in the year to June was up by 2.5%, according to the consumer prices index -up from 2.2% in May and a far worse outcome than the City had expected.

Ed Balls, the economic secretary to the Treasury, responded swiftly to the news that inflation was running 0.5 points above the government's 2% target. "At this time of global uncertainty it is important that policymakers remain vigilant to the risks and forward looking in their approach. Today's inflation data confirm the need for such vigilance in the face of such risks," Mr Balls said.
The Bank of England's monetary policy committee, which sets interest rates, had expected inflation to rise as a result of the sharp increases in energy prices this spring, but sterling rose on the foreign exchanges on the belief that today's data increases the chances of dearer borrowing.
Rates have been left unchanged at 4.5% since a quarter-point cut last August, but some economists believe there is a real chance the Bank will tighten policy next month.
The Office for National Statistics said the cost of fuel and light was up by 28% in the year to June, the sharpest increase since early 1981. Unlike the early 1980s, however, when overall inflation peaked at 20%, domestic fuel and power is increasing at more than 10 times the inflation rate. Over the past year, electricity was up 25% and gas 35%, the ONS said, adding that further increases were to be expected this month and next.
As a result, there were records on all the government's measures of inflation last month. The 2.5% rate on the CPI was the highest since the series began in January 1997, although it was also at that level in September last year. For the first time in almost a year, CPI inflation in the UK is higher than the average for the 25 countries in the European Union.
Inflation as measured by the Retail Prices Index excluding mortgage interest payments -the benchmark used until the switch to the CPI at the end of 2003 - was up from 2.9% to 3.1%, the highest since May 1998.
Another measure of inflation, the RPI excluding mortgage interest payments and indirect taxes such as excise duties, rose from 2.8% to 3.2%. The ONS said it had not been higher for almost 13 years.
Many pay negotiators still use the all-items RPI as the basis for wage claims, and this showed inflation rising from 3% to 3.3% last month, its highest since December 2004.
Mr Balls called on public sector employees to maintain wage discipline and base settlements on the government's 2% inflation target. "We must ensure that continuing responsibility in the private sector is matched by public sector pay discipline, putting jobs and public services first," he said.
In the City, opinion was divided on the implications for interest rates. Some analysts said the Bank would be keen to prevent an upward spiral in inflation, with pay bargainers seeking to compensate for the increases in fuel bills with higher settlements. Others argued that, with unemployment rising, there was little chance of negotiators securing more generous pay increases. The loss of spending power caused by the need to pay more for fuel and power would have a dampening effect on the economy, they said.
"The MPC's May forecast effectively gave the committee an option to raise rates; we think they will exercise that option in August," said RBS UK economist Geoffrey Dicks. "August is by no means a done deal, but if rates are to be raised between now and the end of the year, there is a case for moving in August rather than delaying until the next forecast in three months' time."
Matthew Sharratt, economist at Bank of America, said: "They are a bit of a shock. (But) I don't think they'll be enough to tip the balance of the MPC towards a rate hike as early as August."