Niggardly clothing cuts may bring rate rise

Discounts in July's summer clothes sales were the stingiest since 1990, helping to deliver a surprise jump in inflation and shortening the odds on higher interest rates.

City traders last night were pricing in an increase in rates by the end of the year after the office for national statistics said inflation ticked up to 3.1% last month from 2.9% in June.

The cost of clothes and shoes fell by 3.4% in July - the smallest summer price cuts for more than 10 years. In the same month last year, prices were down by more than 5%. Women's clothes were discounted by almost 8% between June and July 2002 but by 4.4% last month.

Analysts said retailers were probably taking advantage of strong demand in the shops, as temperatures soared, to keep price-cutting to a minimum. "It seems very likely that clothing retailers were encouraged to discount prices by less than usual in the summer sales by the weather-related surge in spending," said Jonathan Loynes, the chief UK economist at Capital Economics.

On the RPIX measure, which excludes mortgage interest payments, inflation rose to 2.9%- well above the 2.5% level targeted by the Bank of England, which is due to give its forecasts for the economy in its quarterly inflation report today.

The renewed rise in inflation, which fell in May and June on the RPIX measure, gave weight to some economists' predictions that the Bank of England will soon be forced to reverse the cut in interest rates it made last month.

"These inflation data are consistent with the strong retail sales and record consumer credit outturns in June and have reinforced market expectations that the next move in interest rates will be up," said Ross Walker of Royal Bank of Scotland, who expects a rise in borrowing costs in the first quarter of next year.

Statisticians said further upward pressure on the inflation rate during July came from a new measure of the cost of airline flights, which jumped sharply as the peak holiday season arrived. Fares and travel costs - including flight prices - were 10% higher in July than a year ago.

The Bank of England will switch to a new inflation target in the autumn, based on the internationally comparable HICP measure, which excludes house prices.

Yesterday's data showed that HICP inflation was running at an annual rate of 1.3% in July. If the chancellor sets the new target at 2%, as many Bank-watchers expect, the monetary policy committee could discover that inflation is well below target when the change-over takes place.

Matthew Jackson of Lombard Street Research said inflation could undershoot a 2% HICP target by more than 1%. If the rules remain the same, that would force Mervyn King, the Bank's governor, to write an explanatory letter to the chancellor. "The first letter of this type in the history of the MPC may not be far away," he said yesterday.

The impact of recent rises in council tax and national insurance contributions on the cost of living was also evident in the figures. The tax and prices index, which includes changes in taxation as well as retail prices, rose at an annual rate of 3.9% in July.

With firms paring back pay deals to cut costs, opposition politicians have warned the sharp rise in the cost of living could leave consumers worse off than they were a year ago.