Inflation likely to ease but rates may still hit 6 per cent

Inflation will take centre stage in a busy week of economic data, which analysts will scrutinise for clues about the next move in interest rates.

Having eased from a decade-high 3.1 per cent in March to 2.8 per cent in April, figures tomorrow are expected to show inflation slowing further to 2.6 per cent in May. But any indication that prices are getting "sticky" will boost speculation that borrowing costs will rise again sooner rather than later, and could hit 6 per cent this year.

The Bank of England's Monetary Policy Committee had a sneak preview of tomorrow's inflation figures before last week's meeting, at which it froze rates at 5.5 per cent. Analysts said the fact that it chose to sit on its hands provides a clue that the numbers will be nothing to panic about.

Philip Shaw, chief economist at Investec, predicts inflation fell to 2.5 per cent in May, still well above the 2 per cent target but a seven-month low nonetheless. "First, we calculate that gas and electricity prices fell by 3.5 and 1 per cent respectively. Second, although food price inflation may remain firm in the longer-term, this month may show a sharp decline from April's 6 per cent. Third, poor weather in May could well have resulted in a smaller than usual rise in clothing and footwear prices," he said.

Paul Dales, UK economist at Capital Economics, agreed that soaring food prices pose a threat to the inflation outlook. "Food prices are now having a similar effect on overall inflation as energy prices and have been the main factor behind the rise in inflation over the last year," he said. "We certainly would not rule out further upward pressure from this source over the coming months."

Producer prices figures today will reveal the extent of inflation pressures at the factory gate. Recent surveys have suggested that manufacturers are enjoying greater pricing power on the back of stronger demand.

The data-packed week also includes figures on the labour market, trade and retail sales and housing market. Research from Hometrack, the housing market analyst, revealed that the plight of first-time buyers struggling to get on the housing ladder is being exacerbated by an acute shortage of one-bed homes. Hometrack shows that there are fewer than 800,000 one-bed properties in England and Wales, just 3.1 per cent of the total housing stock. More than two-thirds (67 per cent) of housing is made up of "family homes" with three or more bedrooms. Three-bed properties account for the bulk (47 per cent) of supply.

There are regional variations, however. In London, where many houses have been split into flats, one-bed homes account for 7.1 per cent of the stock. In Wales, they account for only 1.7 per cent.

Richard Donnell, Hometrack's director of research, said: "The lack of smaller-sized homes, combined with strong demand from investors and first-time buyers, has led to a constant upward pressure on prices at the bottom end of the ladder."

The average price of a one-bed property now stands at £141,000, compared with £194,000 for a three-bed home, a much smaller differential than 10 years ago.