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Last week's retail price data must have been very disappointing for the chancellor. He had been hoping to reduce ba...
Last week's retail price data must have been very disappointing for the chancellor. He had been hoping to reduce base rates further to bolster the government's chances of winning the forthcoming general election. The recent strength of retail sales probably dashed that hope. The issue now is whether he will be able to hold rates down until after the election, or if he will be forced to increase them to counter inflation pressures.

The government targets underlying inflation, which excludes mortgage interest payments, and is aiming for it to fall within a 1 to 2.5% target range by the time of the election. In September it rose from 2.8% to 2.9%.

The composition of the inflation rise is particularly worrying. The rise was not caused by erratic items, such as seasonal foods or petrol prices, but by higher prices for clothing and footwear. Indeed, excluding seasonal foods (as well as mortgage payments) the rate of inflation has increased from 3.2% to 3.7% in the last three months.

Retailers are clearly hoping to take advantage of the recent rise in demand to lift their margins. If they succeed - that is if demand remains strong - then a permanent rise in inflation will be a serious threat. Wage demands will rise in response to higher prices and a mini wage-price spiral could develop.

On the other hand, if consumers react by trimming their spending plans, perhaps maintaining the growth of nominal spending, but cutting real spending growth, then prices will be cut again and inflation will subside.

Whether or not inflation is 'dead' in the UK could be decided in the next few months.

Mhairi Mackelworth, AMP Asset Management.

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