Inflation rose above five per cent in September, ahead of estimates, the Office for National Statistics said on Tuesday, as consumers find that the price of basic goods and fuel are rising well ahead of slow income growth.
The consumer price index (CPI) rose to a three-year high 5.2 per cent, from 4.5 per cent in August, and the retail price index (RPI) hit 5.6 per cent, as higher energy and food prices, the depreciation of the sterling and increases to value added tax (VAT) put upwards pressure on the number.
Earnings growth in August was 1.8 per cent, according to the ONS, and is unlikely to have increased significantly, meaning that wages continue to fall in real terms.
"September’s jump in inflation is particularly bad news for Chancellor George Osborne as it is September’s consumer price inflation rate that is being used to set the increase in many benefits as well as the state pension," Howard Archer, chief UK and European economist at IHS Global Insight said. "As inflation is appreciably higher than was projected by the Office for Budget Responsibility back in March, this adds to the Chancellor’s difficulties in hitting his fiscal targets."
On Monday Prime Minister David Cameron held a summit with the UK's main energy suppliers, in an attempt to find ways to reduce soaring household energy bills.
Economists expect that inflation will start to fall in the new year, as temporary factors dissipate. If it does not, it may force a reassessment of the Bank of England's quantitative easing programme, which could exacerbate inflationary pressures.
"It is very possible that inflation could rise higher still in October as further rises in utility tariffs occur, but inflation should then be at its peak," Archer said. "Inflation should start heading down at the end of the year and then dip markedly at the start of 2012 as the impact of the January 2011 VAT hike from 17.5 per cent to 20 per cent drops out. Consumer price inflation could very well be down near to the Bank of England’s target level of 2.0 per cent by the end of 2012, and it could very well dip below this level in 2013. Much will obviously depend on oil price developments."
The higher than expected inflation will also impact on the government's spending on state pensions and on benefits.
At the Institute for Public Policy Research, senior economist Tony Dolphin, said: "The September inflation number matters more than most because it is used to uprate social security benefits from April next year, and also the state pension when inflation is above 2.5 per cent and the rate of increase in average earnings (which it is). Back in March, the Office for Budget Responsibility (OBR) thought that inflation would be 4.3 per cent in September, so the out turn is 0.9 percentage points above their forecast. As a result, government spending on pensions and other benefits will be £1.2 billion higher in 2012/13 than the OBR thought.
At the Institute of Directors, chief economist Graeme Leach, a vocal supporter of quantitative easing (QE) poured cold water on suggestions that the Bank of England should curtail its asset buying programme.
"The first response to the latest inflation figures is 'ouch'. The second response is more considered," Leach said. "The [Bank of England's Monetary Policy Committee] always knew that inflation would head north of 5 per cent this year, but their main concern was the inflation outlook over the next two years. Hard though it is for many to believe, without QE2 the UK was facing deflation by 2013 because of the weakness of the money supply. Today's figures in no way undermine the MPC's decision to launch QE2. Don’t forget that in 2008/9, inflation fell from 5 per cent to 1 per cent in just 12 months.”