Soaring food and energy bills as well as the weakening value of the pound are driving inflation upwards and will push it over five per cent later this year, the governor of the Bank of England Mervyn King wrote in an official letter to Chancellor Alistair Darling yesterday.

Figures from the Office of National Statistics (ONS) revealed that inflation has hit a 16-year high, with the Consumer Price Index (CPI) rising from 4.4 per cent in July to 4.7 per cent in August. The inflation rate has doubled since the beginning of this year, and this month’s increase was again higher than economists had expected.

However, there was some relief that the Retail Price Index (RPI), which includes housing costs, fell slightly from five per cent in July to 4.8 per cent in August, reflecting the fall in house prices due to restricted mortgage lending in recent months.

The high inflation figure is putting the Bank in England in a difficult position to cut interest rates in order to fight back the worst impact of the credit crunch, as a rate could exacerbate inflation further. By contrast, in his letter to the Chancellor Mervyn King indicated that a rise in rates, although unlikely, could no longer be ruled out.

Minutes of the Monetary Policy Committee’s (MPC) meeting earlier this month published today show that the Bank of England’s policymakers remain undecided about which way to chose, as eight out of nine members of the MPC voted to keep rates at the current five per cent. Only one member, David Blanchflower voted for a cut by 0.5 percentage points.

Although the majority of economists predict that inflation will still get worse before it gets better again, many believe that there is light at the end of the tunnel and that recent events at the stock markets will prompt the bank to cut rather than raise rates in order to prop up the economy.

Mervyn King wrote that the economic slowdown could help lower the inflation rate in the next year, expressing the Bank’s Monetary Policy Committee’s belief that “a period of muted economic growth is necessary to dampen pressures on prices and wages and return inflation to target in the medium term.”

Inflation hit pensioners and families on low incomes hardest, as figures from both the Alliance Trust and PricewaterhouseCoopers show that inflation figures for these groups are well above the national average of 4.7 per cent. Low-income families saw inflation rise to 5.7 per cent and pensioners by a whopping seven per cent, as both tend to spend a higher percentage of the income on gas and electricity, and food – which are the items that made inflation soar in the first place.

The good news for those on lower incomes in particular is that the continuing growth of discounters and a price war between the big supermarkets has led the two biggest supermarkets Tesco and Asda to slash prices and introduce more discount products in order to stop consumers to defect to German discounters Aldi and Lidl.

Tesco announced the launch of a new range of 350 cheaper range products and price cuts of hundreds of existing products, while Asda followed suit with dropping the prices of more than 5,000 products.

“The centre of gravity in the marketplace has moved,” said Richard Brasher, commercial director of Tesco, “even for people who have money, so they are demanding value at every part of the shopping trip.” With supermarkets eager to attract and retain customers, those may benefit sooner rather than later and end up with more money left in their pockets at the end of each month.

© Fair Investment Company Ltd