Inflation through three per cent

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Bank of England governor Mervyn King has been forced to write an explanatory letter to chancellor Gordon Brown after consumer price index (CPI) inflation rose to 3.1 per cent in March.

The open letter was prompted by CPI inflation drifting over three per cent – one percentage point about the two per cent inflation target set by Mr Brown on the establishment of the monetary policy committee (MPC) ten years ago.

Today's letter is the first time since Mr Brown delegated responsibility for setting interest rates to the Bank of England in 1997 that such a letter has had to be written – a point Mr King is keen to emphasise.

"I am surprised that it has taken ten years and 120 meetings of the MPC before a deviation from inflation from target sufficient to trigger a letter has arisen," he writes.

"When the MPC was set up in 1997 the chances of going almost ten years without an open letter being triggered seemed negligible."

Explaining why he had allowed inflation to diverge away from the three per cent upper threshold, Mr King said that he had been directed by Mr Brown ten years ago to avoid distorting the UK economy in ways which could provoke "shocks and disturbances".

He outlined a series of factors which placed upward pressure on inflation in recent months, including recovering spending in the UK economy, sharp domestic energy price increases and increased capacity pressures.

In the short term, higher petrol prices, a record increase in furniture and furnishings and retailers putting up prices prior to Easter discounting contributed to the March figure, Mr King explained.

Despite these failures Mr King wrote that the MPC would "continue to look through the short-term volatility in inflation" to the anticipated fallback to the two per cent target by the end of the year.

Whether that will prevent the MPC from raising interest rates when it next meets remains to be seen.

Analysts have said it seems almost inevitable that the MPC – already uncertain as to whether a hike will be necessary before the expected falloff takes place – will raise rates from their current 5.25 per cent in May's decision.

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