Inflation hits 26-month high

Britain's underlying inflation rate has hit a 26-month high of 2.4%, according to the latest consumer prices indices released by the Office of National Statistics (ONS) this morning.

Economists had expected unchanged figures and the latest data has sparked fears that the Bank of England may decide against any further interest rate cuts - a move it had been widely expected to make at its next meeting on July 5.

The figures show that in the 12 months to May, the all-items excluding mortgage interest payments index (RPIX) rose to 2.4%, up from 2% in the previous month. Analysts had widely expected inflation to be nearer 2.1%. The Bank of England bases its interest rate decisions on the RPIX. Underlying inflation is now just below the Bank of England's target of 2.5%.

The all-items Retail Price Index (RPI) - the headline inflation rate - also rose to 2.1%, up from 1.8% in April. According to the ONS analysis of the figures, the largest upward effect on the all-items' 12-month rate came from changes in food prices and, predominantly, those for seasonal food: poor weather conditions have increased the price of fresh vegetables and potatoes; and rising oil prices, as well as increasing car prices, have also contributed to the upward effect.

The largest downward effect, on the other hand, came from price changes for housing costs and, more specifically, the mortgage interest payments component, as the majority of high street lenders decreased their rates in May.

Financial markets have reacted swiftly to the news, with short sterling interest rate futures and gilts tumbling on perceptions that there would be no further cuts on top of the three that the Bank of England has already delivered this year. It is now expected that the Bank of England will in fact increase rates from their current level at 5.25% by the end of the year.

"Going forward, it will be important to see whether the gap between goods prices and services prices will close," commented Stuart Green of Credit Lyonnais. "If sterling continues to weaken and goods prices tick up, that will put pressure on the Monetary Policy Committee to raise rates."

"We could be looking towards an earlier rate hike possibly in the first half of the next year rather than the second half," he added. "This is an additional cloud over the MPC which encourages the view that rates have bottomed, especially if inflation continues to deteriorate from here."