Interest rates unlikely to rise until 2012, say City analysts

Analysts said the deep discounts on offer in the high street last month reflected the squeeze on real incomes The City was last night ruling out an increase in interest rates until next year after latest cost of living figures showed Britain’s struggling retailers were forced to cut prices aggressively last month. Speculation that borrowing costs will need to be raised to tackle price pressures was dampened after the Office for National Statistics (ONS) said the government’s preferred measure of inflation dropped unexpectedly from 4.5% to 4.2% in a month. On a day of widespread financial market unease, triggered by the deepening crisis in the eurozone, the prospect of the Bank of England pegging interest rates at 0.5% well into 2012 left sterling under pressure on the foreign exchanges. Analysts said the deep discounts on offer in the high street last month reflected the squeeze on real incomes caused by a combination of rising inflation and modest pay awards. Prices of clothes, shoes, computer games and toys saw particularly large cuts as retailers sought to woo cautious consumers. Although retailers have been buffeted by higher energy prices and the rising cost of imports, Graham Turner of GFC economics said they were unable to pass on the higher prices to their customers. “Once again, there was clear evidence of consumer resistance to cost increases, a product of the biggest decline in real employee compensation since 1977,” Turner said. Recently announced increases in domestic energy tariffs are likely to send inflation as measured by the consumer prices index (CPI) higher over the next few months, but yesterday’s data strengthened the hand of those members of the Bank of England’s monetary policy committee who have been arguing against a rise in borrowing costs. Led by the Bank’s governor, Mervyn King, a majority on the MPC believes that the surge in inflation to more than double the government’s 2% target will prove temporary and that tightening policy would risk damaging an already weak economy. Separate ONS figures for UK trade showed a widening gap between imports and exports in May, the latest month for which data is available. News that the trade deficit widened from £7.6bn to £8.5bn dented ministerial hopes that the squeeze on consumer and public spending will be offset by stronger export performance. The City is now nervously awaiting the release of growth figures for the second quarter of 2011, due at the end of this month, and has started to mull the possibility that the Bank will inject a fresh dose of electronic money into the economy by buying bonds from banks. The Bank boosted the money supply by £200bn during the recession in an attempt to boost growth but has not added to its quantitative easing programme since early 2010. Jonathan Loynes, chief European economist at Capital Economics said yesterday’s figures added “support to the growing view that UK monetary policy is more likely to be loosened than tightened over the next year or so”. The ONS said prices fell by 0.1% last month, the first drop in June for eight years. Games, toys and hobbies were 5.7% cheaper than in June 2010 while audio-visual equipment showed an 11.5% annual drop. The ONS said rising supermarket bills limited the fall in headline inflation last month, but so-called core inflation – which excludes food and energy prices – dropped from 3.3% to 2.8%. Other measures of inflation also fell last month. The retail prices index – used in the bulk of pay negotiations – dipped from 5.2% to 5%, while the CPI excluding the impact of indirect taxes such as VAT came down from 3% to 2.7%. Angela Eagle MP, shadow chief secretary to the Treasury, said: “It is worrying that inflation is still more than double the government’s target rate. “Rising world commodity prices are partly to blame. But things have been made much worse in Britain by George Osborne’s big rise in VAT, which is due to his decision last year to cut the deficit too far and too fast. “Families and pensioners who are already being squeezed hard by the Tory VAT rise and cuts to tax credits now face the prospect of huge rises in their gas and electricity bills too.” Simon Rose at Save our Savers said: “The slight improvement in this month’s inflation figures will bring little comfort to savers. It is scandalous that the Interest rates Economics Retail industry Bank of England Economic policy Larry Elliott guardian.co.uk

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