Fresh inflation fears as target figure rises

DIANE COYLE

Economics Editor

In an embarrassing reverse the Government's target measure of inflation increased in February, even though headline inflation fell to its lowest for 15 months.

The disappointing rise in underlying inflation, along with a jump in manufacturers' optimism reported by the Confederation of British Industry this morning, will make faint hearts in the City play down hopes of another reduction in base rates. However, most analysts said yesterday that the inflation outlook remained good.

Falling beef prices will be one contributory factor. On the cautious assumption that beef drops by a fifth in price, it will reduce the annual rise in food prices by one percentage point, and headline inflation by 0.1 points.

Other downward influences on inflation are the recently announced mortgage rate reductions, and continuing petrol and supermarket price wars.

The headline inflation rate fell from 2.9 per cent to 2.7 per cent in February, the lowest since November 1994. The annual increase in the RPI less mortgage interest relief rose from 2.8 to 2.9 per cent, compared with its 2.5 per cent target.

Lower mortgages made the biggest contribution to the decline in the headline rate, as home loan rates climbed last February. The mortgage effect will help the retail price index until at least April. Higher house prices offset some of the effect on total housing costs last month.

Motoring costs also made a significant contribution thanks to petrol on average 1.5p-2p a litre cheaper than in January.

The biggest upward pressures on inflation last month came from tobacco and food. Food prices climbed 4.5 per cent in the year to February. Non- seasonal food price inflation reached 4.9 per cent, its highest since July 1991.

Higher packaging costs due to pulp and metal costs, weather-related shortages and higher prices of raw materials such as flour, sugar and beans for baking lay behind these rises. Pork and bacon prices have been rising for several months as a result of a piglet shortage. More expensive packaging also accounted for increases in the price of personal goods such as cosmetics and toiletries.

Economists were divided about the significance of last year's high raw materials costs being passed through to retail prices at last. Ian Shepherdson at HSBC Markets said: ''This is nothing to worry about unduly. There is no sign of across-the-board pressure.'' But Kevin Darlington at Hoare Govett said: ''High street demand should be sufficiently buoyant to enable retailers to push through price increases this year to restore margins.''

The CBI's latest monthly survey of industrial trends was equally mixed. The balance of firms reporting higher rather than lower orders this month was the weakest since the end of 1993, at minus 15 per cent. The minus 5 per cent balance for export orders was the weakest for nearly two years.

In addition, the build up of stocks continued, with a balance of 20 per cent of firms reporting more than adequate stocks compared with 16 per cent in February.

The balance of firms expecting to raise prices fell to 13 per cent, the lowest since October.

On the other hand, in a surge of optimism not reflected in recent conditions, manufacturers' output expectations returned to their highest level since last May. A balance of 24 per cent expect output to grow during the next four months.

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