Dear Alistair...

Dear Alistair...

When the Bank of England announced last week that it was leaving interest rates at 5% the suspicion was that the nine members of the monetary policy committee knew something that we didn't. As today's dreadful inflation figures show, they did. The Bank knew that the government's preferred measure of the cost of living was about to leap from 2.5% to 3% and in those circumstances a cut in interest rates was unthinkable, since it would have given the impression that the MPC was playing fast and loose with its mandate to keep inflation at 2%.

The chances are that the rise in petrol prices seen over the past few weeks will push inflation as measured by the Consumer Prices Index even higher next month, triggering only the second letter that the governor of the Bank of England has had to write to the chancellor explaining what the Bank has been up to. Last spring, it was quite simple for Mervyn King to tell Gordon Brown that the Bank had already taken steps to bring inflation back below 3%, since the MPC had raised rates three times since the summer of 2006 and would increase them twice more before the financial crisis broke.

This time, King would face a much more difficult task with his "Dear Alistair" missive. "Dear chancellor", the letter might say, "inflation has risen above 3% as the result of soaring global fuel and food prices and the response of the Bank has been to cut interest rates because we think that the long-term risk of economic recession is.....continued below

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more serious than the risk of an inflationary spiral."

That, indeed, is what some economists do believe, although only one of them - David Blanchflower - currently has a seat on the MPC. The other eight members take a much more cautious view, and that means a rate cut next month now looks extremely unlikely.

Reasons for the spike in inflation last month are not difficult to find. Food costs a lot more than it did this time last year, with the 7.2% annual rise the highest since the CPI was first used as a measure of inflation in 1997. The big energy companies have been jacking up fuel bills and oil prices at $125 a barrel mean it costs a lot more to fill up the family saloon. Budget increases in the price of booze didn't help either. Worryingly, however, so-called core inflation - which strips out food, fuel and budget increases - also picked up last month, from 1.2% to 1.4%, suggesting that part of the increase in costs being faced by producers is being passed on to consumers. And inflation in services jumped from 3.4% in March to 3.7% last month, well above the 2.8% in the euro area.

In normal circumstances, such dismal figures would prompt talk of borrowing costs going up not down. These, though, are not normal times - as today's surveys from the British Retail Consortium and the Royal Institution of Chartered Surveyors showed only too clearly. Almost every estate agent in the country is reporting a drop in house prices and activity is falling like a stone. With an ever-bigger share of household budgets being eaten up by visits to the supermarket and the filling station, there is less left over for spending on luxuries. That's why the BRC said like-for-like sales have fallen for the past two months - the first back-to-back falls in three years. This picture was underlined by today's inflation data: clothing and footwear prices are sharply lower as retailers try to attract reluctant shoppers to part with their money.