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Last Updated: Tuesday, 16 January 2007, 18:35 GMT
Analysis: Why the sharp rise in inflation?
Evan Davis, BBC Economics Editor
By Evan Davis
Economics Editor, BBC News

Bank of England
The Bank could be facing a bleak decision on interest rates
When the retail prices index was last growing this quickly, 15 years ago, interest rates were at 10.5%.

They're not likely to go that high any time soon, but that does emphasise that in the decade of Bank of England independence we have become accustomed - perhaps too accustomed - to inflation that's low and stable, and the interest rates that go with it.

We've enjoyed all this, partly thanks to falls in the global prices of manufactured imports, from Chinese textiles to toys.

And thanks to high levels of inward migration which have kept wages in check and removed bottlenecks in the economy.

Those disinflationary pressures, allowed the Bank of England to keep rates low, and let spending grow fast without the rising prices that curtailed previous periods of growth.

Energy pressures

So what if anything, has gone wrong now?

Arguably, the benefit of cheap imports from is China is beginning to diminish as higher energy prices kick in.

The average price of manufactured goods (excluding fuel) is still falling. But it's not falling as quickly as it was a year ago. So its downward effect on the overall inflation figure is weaker than it used to be.

If that's right, the Bank has to start applying the brakes. Indeed, it might be thinking it should have done so earlier.

Blip?

On the other hand, inflation concerns could still fade this year.

Remove energy prices, and the Consumer Prices Index (CPI) is more or less on target.

And the helpful news is that energy prices are not still rising. So their inflationary effect on the annual rate of inflation should drop out of the figures this year, and CPI inflation should fall back.

The Bank can't afford to take a chance and dismiss this inflation spike as a mere blip.

It's done a remarkable job of delivering inflation on target so far - the average rate of inflation since 1997 has deviated from the target by a 0.1 percentage point.

But after 10 years of independence, the Bank faces its biggest headache.


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