Rates cut hopes dashed

The prospects of further cuts in interest rates receded yesterday with the release of inflation figures showing upward pressure on prices for food, clothes and household goods.

With the summer sales delayed as a result of strong consumer demand, City expectations of a fall in underlying inflation in June were not met when the annual increase remained unchanged at 2.4%, just below the government's 2.5% target.

Analysts had been predict ing a fall in inflation excluding mortgage interest payments to 2.2% following May's surprisingly hefty increase, and said that the Bank of England's monetary policy committee would respond to the data by leaving interest rates on hold at 5.25% when it meets early next month.

The figures from the office for national statistics showed that cheaper mortgages were responsible for a fall in the all-items inflation rate from 2.1% to 1.9% last month. But once home loans were stripped out, the ONS said, the core inflation rate had remained unchanged.

Without the cuts in excise duties announced by the chancellor, Gordon Brown, in the Budget in March, price pressures would have been still higher. Excluding both mortgages and indirect taxes, inflation last month was 2.8%.

Food prices last month were 5.6% higher than a year earlier, the fastest rate of increase for almost six years. Officials said the wettest winter on record was still having an impact on prices of potatoes, up 77% on a year ago, and fresh fruit. Non-seasonal food prices also rose.

Elsewhere in the high street, there was less discounting of clothes and shoes this year, while the buoyancy of the housing market fed through into higher prices for furniture. The upward effect of price increases from the retail sector was offset by the impact of motoring costs, where petrol prices remained unchanged this year in contrast to a 4p per litre rise in June 2000.

Michael Saunders, an economist for Salomon Smith Barney Citibank, said that interest rates would remain unchanged for the rest of the year but rise by 0.75 percentage points in 2002. Although Britain's inflation rate remains the lowest in the European Union, Mr Saunders added: "The UK is losing its status as one of Europe's economic outperfomers.

"The MPC are losing the flexibility to cut quickly in response to any signs of economic weakness that was granted by sub-target inflation."

Jonathan Loynes, an analyst at Capital Economics, said the inflation figures put a dent in hopes for lower rates and were a "serious blow" for manufacturers affected by the double impact of slower global growth and a strong pound.

Further evidence of Britain's two-speed economy came from separate ONS data showing that the turnover of the engineering industries was 6% lower in the three months to May than during the previous quarter. Export turnover was down by 8.9%.

Figures from the United States showed that industrial output is also falling in the world's largest economy.

Manufacturing output declined for the ninth consecutive month, dropping by a larger than expected 0.7% in June. The contraction in US industry is now the longest since 1982, with spare capacity at its highest since 1983.