Inflation rise may end fall in interest rates

Britain's 11m mortgage payers were served a warning yesterday that the move to lower interest rates may be coming to an end after government figures showed the annual inflation rate rose sharply last month to its highest level in more than two years.

A severe shortage of vegetables caused by the wettest winter in more than two centuries and the impact of rising oil prices on motoring costs pushed up inflation excluding mortgage interest payments from 2% in April to 2.4% in May, the office for national statistics said.

The size of the monthly increase - not exceded since the Iraqi invasion of Kuwait in August 1990 - took the City by surprise and left most analysts convinced that the Bank of England would now be reluctant to reduce interest rates from their current level of 5.25%. Economists said inflat-ion would be above the government's 2.5% target were it not for Gordon Brown's changes to excise duties in the Budget that held down price increases for cigarettes, alcohol and petrol.

David Page, economist at stockbrokers Investec, said: "The figures are a shock; they are a very poor set of data. It will be a very difficult decision, but the manufacturing sector will have to show a significant contraction for the Bank of England to move."

Cheaper mortgages ensured that the all-items inflation rate showed a smaller increase than the underlying rate, but still rose from 1.8% to 2.1% last month.

The ONS data showed the full impact of the winter floods coming through into prices in supermarkets, with food prices up by 2.4% in May, the biggest one-month rise for almost 20 years. Seasonal food prices rose by 12.7% last month, with potatoes 71% dearer than a year ago and fresh vegetables up 41%.

"There have been large price increases across all outlets due to reduced supplies following the wet weather and poor growing conditions which have hampered planting and harvesting," the ONS said.

It added that motoring costs also rose markedly last month, with the price of petrol at the pump edging up by 1p to 2p a litre because of cuts in crude oil production.

Although the figures were distorted by the twin effects of dearer food and petrol, analysts said there were also signs that the strength of consumer demand was allowing retailers to push up the price of household goods, clothing and footwear and a range of service-sector items.

Michael Saunders, UK economist at Salomon Smith Barney, said the underlying price pressures were likely to continue, and predicted that the Bank of England would be one of the first central banks to raise interest rates once the current downturn in the global economy had ended.

"The recent CBI retail survey suggested that retail goods prices are rising for the first time in two years, probably because import prices have been pushed up by the drop in the pound over the past year," he said. "At the same time, services inflation is likely to continue to be pushed up by the pickup in pay growth."

With other countries also affected by rising global energy costs and dearer food, Britain's inflation rate remains the lowest in the EU.

The harmonised measure used to compare the cost of living across the EU's 15 member states showed the UK's inflation rate at 1.7%, compared with an average of 2.6% for the EU and 2.9% for the 12 members inside monetary union.