UK inflation stays at two-year high

UK inflation has remained at a two-year high, as food prices continue to surge, official figures have revealed.

Prices were 2.4% higher in June than the same month a year before, data for underlying inflation has shown.

The data disappointed the City, which was hoping that the surge in underlying inflation to 2.4% in May could be disregarded a one-off blip.

Shares slipped on the back of Tuesday's data, with the benchmark FTSE 100 index closing 89.3 points lower at 5,427.8 points.

Seconds before the data was released, the index was down 45 points.

Sentiment was further soured by a separate report showing a 6.0% slump in turnover at engineering firms in the three months to May, compared with the quarter before.

Firms making electronic and optical parts were worst hit, reporting a 7.7% decline in overall turnover and a 9.9% plunge in exports.

Food prices rise

The price index report revealed that headline inflation, a broader measure that includes prices of more volatile factors such as mortgages, actually declined in June, when compared with the month before, the Office for National Statistics (ONS) said.

Shopper: paying more for food

The fall to an annual rate of 1.9% last month from 2.1% in May reflected lower mortgage rates following recent cuts in the UK interest rate, and a deceleration in the housing market, the ONS said.

But City analysts regard the underlying inflation rate, which excludes mortgage interest payments, as painting a more accurate picture of UK inflation.

The data showed that food prices were 5.6% higher last month than in June 2000, with highest rises seen in poultry, pork and soft drinks.

Prices of books, newspapers, photographic equipment and toys also had an upward effect, with tobacco 4.2% more expensive, Tuesday's report revealed.

A slowing in the rate of petrol price rises offered some balance to rising food costs.

Interest rates

The figure diminishes prospects of an imminent cut in UK interest rates, which would feed through to lower mortgage rates, and lower returns for investors with deposit or building society accounts.

The Bank of England, which sets UK rates, is charged with an inflation target of 2.5%, and may feel that any move to stimulate the economy would risk sparking excessive price rises.

Jeremy Hawkins, analyst at Bank of America, said Tuesday's data supported his view that interest rates will remain at 5.25% until the end of the year.

"The UK inflation data may be slightly disappointing but at the end of the day the key [figure] is still below target," he said.

While some analysts are pointing to rises in interest rates, inflation is still sufficiently low to allow the Bank of England room to pursue a steady-as-she-goes approach, Mr Hawkins added.

"The bottom line is that inflationary pressures are subdued enough that the Bank of England can happily leave interest rates on hold for some while to come."

Weather effect

Philip Shaw, an economist at Investec in London, forecasts a slowdown in price rises as the recent pick-up in UK weather boosts farm output.

Wet weather, and poor growing conditions are viewed as a key factor in recent rises in food prices.

"These [inflation] figures are clearly disappointing as they are a touch above forecast," Mr Shaw said.

"However, the better weather in recent months means it is only a matter of time before food prices start coming down again."

Electrical firms slump

The UK engineering report will heighten fears raised by an Engineering Employers' Federation report two weeks that the sector has entered recession, defined as two successive quarters of contraction.

And it comes less than two weeks after telecoms equipment firm Marconi, one of the UK's largest engineering firms, shocked the markets by warning of a "very, very significant" slowdown in European trade.

Orders to electrical engineering companies, until recently the most buoyant part of the sector, were 7.6% lower over the March-to-May quarter than over the three months before, the ONS said.

Machinery and equipment firms, which have experienced a longer-term decline, saw orders decline by a more modest 1.7% during the period.