By Claire West

Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club; and David Kern, chief economist for the British Chambers of Commerce, comment on the latest inflation figures:

Comments on today’s inflation figures:

Another upside surprise and its now almost certain that CPI inflation will hit 4% in early-2011.

There is significant upward pressure coming from commodity prices and austerity measures will soon add to them
This will make the monetary policy debate even more tense, but the MPC should be wary of raising rates.

Another major upside surprise with the biggest November-December rise in prices on record. The bulk of the increase has come from external pressures, with surging commodity prices driving up the cost of a range of goods from petrol to domestic fuels to food.

Given that commodity prices have risen further over the past month and that we have a range of austerity-related measures — including VAT, fuel duty and rail fares — due to hit the index in January, we are likely to see another high number next month. Indeed it would now be a major surprise if CPI inflation did not hit 4% at some point in the next couple of months and inflation is likely to remain above 3% for much of the year, triggering a series of letters of explanation from Mr King to the Chancellor.

“However, while this release will no doubt make uncomfortable reading for the MPC, we maintain that it should not cause them to raise interest rates. VAT continues to account for a large part of the overshoot of the 2% target, while the recent rises in commodity prices should soon abate. With no sign of any second round effects on wages, we expect inflation to drop back to target at the beginning of next year as the VAT rise falls out of the calculation.

“The MPC cannot do anything about the inflation rate over the next couple of months and we are confident that this will not distract them from the job in hand of targeting inflation two years out. There are still some major downside risks out there, in particular the reaction of the domestic economy to the austerity programme, and to raise rates this early would be a major risk. The monetary policy debate is going to be fierce over the first half of this year but we back the MPC to hold their nerve and keep interest rates at 0.5%.”

Mirroring these sentiments is David Kern, chief economist at the British Chambers of Commerce:

“But our view remains the same — raising interest rates at a time when fiscal policy is being tightened, while businesses and individuals are facing greater pressures, would be a mistake and should be avoided. The factors contributing to inflation at present are also adding to the squeeze on profits and disposable incomes. We believe that interest rates will have to increase later in the year, but it is critical that the MPC waits until the initial impact of the tough austerity measures have been absorbed.

“An early increase in rates will make no difference to inflation in the short-term, but would risk derailing the recovery and would make it more difficult for the government to implement its deficit-cutting programme.”