UK inflation reached an almost two year high last month with the consumer price index (CPI) 3.7% higher than a year ago. The Bank of England target is for the CPI to rise by an annual rate of only 2% and December was the thirteenth month that the target had been breached.
Inflation has been boosted by soaring energy costs and rampant global food prices, and with the VAT hike this month and commodity prices continuing to rise, the outlook is for inflation to break through the 4% barrier this month. Even core inflation (which excludes taxes and highly seasonal items such as food and energy) is rising at a rate of just under 3%.
The inflation outlook has produced a policy dilemma for the Bank of England. Under different circumstances the Bank would be aggressively pushing up interest rates in order to choke off inflationary pressures. But the Bank has been holding down interest rates in order for the UK economic recovery to take hold, with the hope that inflation would subside in the medium term. But the recent spurt in inflation threatens to undermine the Bank's strategy.
The Bank of England's Monetary Policy Committee has been split over when the next interest rate should be. It now looks likely that the first interest rate hike will take place in the summer of 2011, which will be followed by a series of rises throughout the rest of 2011 and 2012.