Retail price inflation stuck at two-year high as rates hopes pinned on slowdown

The rain in Spain, a plague of caterpillars and striking French lorry drivers all contributed to a surge in lettuce prices last month. It was one reason for the stubborn refusal of inflation to decline from a two-year high. As Diane Coyle, Economics Editor, reports, this means the outlook for interest rates hinges on a sharp slowdown in growth.

Dearer fresh vegetables and secondhand car prices were the main culprits behind retail price inflation that stuck at 3.7 per cent in November, the highest rate for more than two years. The target inflation measure, which excludes mortgage interest costs, was also unchanged at 2.8 per cent.

The most dramatic increase was a 55 per cent surge in the price of lettuces. Not only did heavy rain and warm temperatures infest the Spanish crop with caterpillars, but the surviving lettuces had to be shipped by air, rather than driven across France as usual, because of the truck drivers' strike.

With black rot now afflicting the Irish brussel sprout and cabbage crops, other seasonal foods remain vulnerable to increases. But even though many other categories put downward pressure on the inflation rate, economists said yesterday's figures were disappointing.

David Walton at Goldman Sachs said: "Unless there is a sudden reversal of the inflation trend in the next couple of months, the government's 2.5 per cent target may prove elusive."

Pessimists reckon that the economy is heading for a difficult period when growth will dip while inflation will not. Unless the slowdown is a steep one, the Bank of England might feel compelled to increase interest rates again.

Adam Cole at James Capel said: "If the collapse in growth that the Bank of England anticipates fails to materialise, rates have further to rise." Goldman Sachs, too, is predicting another half-point increase in the cost of borrowing.

Signs that the housing market is cooling off will help ease any interest rate pressure, however. The Nationwide Building Society yesterday predicted house price inflation would decline to 7 per cent next year from 12 per cent this year.

The report concluded: "It is likely that successive rises in base rates this year are impacting on buyer confidence." Properties remained in short supply but demand had started to fall back.

Homes remained very affordable and personal incomes were still growing, the Nationwide noted. Paul Sanderson, head of research, said: "The recovery in the housing market should have further to go next year, particularly outside London and the South-east."

But it had been a subdued recovery by historical standards, he said. The housing market would not prove immune to higher mortgage costs and a weaker economy.

Estate agents Knight Frank added their support with a prediction that London house price inflation would be 8 per cent to10 per cent in 1998, compared to up to 20 per cent this year.

However, both forsee more of a slowdown than the investment bank Merrill Lynch. In a recent report it predicted house price inflation approaching 10 per cent next year, not much weaker than this year.

According to yesterday's official figures, housing costs in November were 9.2 per cent higher than a year earlier, the fastest annual rate since March 1991. Annual inflation in seasonal foods was 4.9 per cent, the highest since mid-1996.

Over a longer period, services prices have been outpacing increases in the cost of high street goods - and would have climbed even faster but for price cuts introduced by the regulated utilities. These reductions will soon drop out of the annual inflation figure as it is almost a year since electricity bills started to fall.

While electricity prices were 7 per cent lower than last November, gas prices 3 per cent down and phone bills at the same level, the price of leisure services such as holidays and entertainment was up 5.7 per cent, personal services such as haircuts up 6 per cent and domestic services up 4 per cent.

Without the depressing effect of the strong pound and stiff competition on goods such as consumer electronics and alcoholic drinks, the inflation performance last month could have turned out to be even more disappointing. But some analysts argue that more of the reduction in import prices ought to have fed through to the high street.

Mr Cole said: "Retailers have used the fall in import prices to expand margins."

Figures for prices in December and January will be affected by increases in tobacco, alcohol and vehicle excise duties announced in the July Budget.