Pay pressures rise as inflation hits 8-year high

Headline inflation hit its highest level for eight years last month, keeping the prospect of another rise in interest rates alive despite a weaker than expected out-turn for the measure that the Bank of England targets.

Official figures yesterday showed RPI (retail price index) inflation, which will be used in the new year pay round, rose to 3.7 per cent in October, up from 3.6 per cent in September and the highest since June 1998.

However, the rate the Bank targets, CPI (consumer price index) inflation, was unchanged at 2.4 per cent - in the face of City forecasts for a rise to 2.6 per cent - although still above the 2.0 per cent target.

It also reduces the chance that CPI will hit 3.1 per cent - the level at which Mervyn King, the Governor, would have to write an open letter of explanation to the Chancellor, Gordon Brown.

The mixed picture has put even greater importance on the Bank's quarterly inflation forecasts, published today, that should give a better guide to the need for another rate rise in February.

"While these figures provide some ammunition for the doves [on the Monetary Policy Committee], the real test will come from the inflation report," said Rob Carnell, a senior economist at ING Financial Markets.

Analysts were split between the weakening in short-term inflation pressures and warning of fears of a spike in wage claims in the new year. Jaspreet Sehmi, an economist at the City analysts CEBR, said: "UK inflation stays steady for now, but the Bank is still wary of trouble ahead."

Howard Archer, chief UK economist at Global Insight, said the Bank would "not hesitate" to pull its interest rates trigger if wage settlements accelerated.

But Karen Ward, UK economist at HSBC, said both GDP and inflation have come in weaker than the Bank had expected at its last inflation report in August. "We continue to believe 5 per cent will prove the peak in rates," she said.

"The Bank really needs the prices of goods and services to pick up in order to not undershoot the target next year."

The inflation picture was clouded by two one-off factors pulling in opposite directions. The largest upward effect was the decision by most universities in England and Northern Ireland to raise their fees to £3,000 from £1,750 for the new academic year. However, the move made a smaller-than-expected contribution - 0.12 rather than 0.25 percentage points.

Meanwhile, food prices rose at their fastest annual rate for more than five years. The growth in the price of fish, bread and vegetables has risen more than fourfold since May. However, a 5p fall in the price of a litre of petrol cut almost 0.2 per cent off inflation.

The gap between CPI and RPI inflation hit its widest level for 18 months in October, the Office for National Statistics said.