Consumers will be saddled with soaring bills this year as Mervyn King, the Governor of the Bank of England, admitted that inflation will rise to more than 4 per cent.

In an official letter to the Chancellor explaining how he had failed to keep the lid on prices, Mr King said that increasing food, fuel, gas and electricity costs sent the consumer prices index spiralling to 3.3 per cent in May, up from 3 per cent in April. Economists had expected a more modest rise to 3.1 per cent.

He also cautioned that inflation, which the Bank of England tries to keep near its target of 2 per cent by adjusting the base rate, would rise further this year and was unlikely to fall back below 3 per cent until “well into 2009”. The more traditional retail prices index, which includes mortgage bills and council tax and is judged by many to be a closer reflection of the cost of living, also rose, from 4.2 per cent to 4.3 per cent.

It is only the second time in the 11 years since the Bank gained independence and assumed responsibility for inflation that the Governor has had to write such a letter of explanation to the Treasury. He must write when inflation breaches the 3 per cent threshold and every three months thereafter until it falls below 3 per cent. Mr King admitted yesterday that more letters were likely to follow over the next year.

However, share prices rose as City analysts detected a conciliatory tone in the Governor’s comments. They now forecast that there will be only one quarter-point rise in interest rates before November, not two as had been feared. The FTSE 100 index ended the day up 67.3 points at 5861.9.

Mr King emphasised the temporary nature of the surge in inflation, saying that almost all the increases were due to rises in food, fuel, electricity and gas. “Although this clearly raises the price level, it is not the same as continuing inflation. There is not a generalised rise in prices and wages.”

But there are fears that workers could step up pressure on employers to increase wages as their incomes are stretched to the limit. This could spark a wage-price spiral, further fuelling inflation. However, Mr King ruled out an abrupt rise in interest rates to try to bring down inflation immediately, arguing that it would have too disruptive an effect on economic output and jobs.

The base rate has been cut three times since December, although the benefit to many borrowers, including mortgage holders, has been muted because banks, who are being battered by the fallout from the credit crunch, have not passed on the full benefit to existing borrowers. Lenders are also demanding much heftier deposits and charging higher rates for new borrowers as they conserve their cash.

Fuel prices have increased at their fastest rate in the past month, according to the AA. A litre of diesel now costs about £1.31, up from £1.24 last month, while unleaded petrol has risen by 5.61p to £1.18 per litre.

The biggest factor in rising inflation was the growing price of food and nonalcoholic drinks, said the Office for National Statistics, which published the inflation figures. The cost of meat and vegetables soared. Increasing household energy bills were also a major component, as well as the rising cost of books, stationery and foreign holidays.

But Mr King said that the leap in inflation was outside the Bank’s control. He pointed out that world agricultural prices had risen 60 per cent in the past year, crude oil was up by more than 80 per cent while wholesale gas prices had leapt 160 per cent. He highlighted that inflation was higher in both the eurozone economies and the US. He argued that the rise in inflation would be temporary as the dual pressures of the squeeze on household incomes and the credit crunch would slow the economy, dampening inflationary pressures.

Alistair Darling, the Chancellor, in his own open letter, said that he agreed with the Governor’s assessment and called for pay restraint.Ana-lysts at HSBC, Europe’s biggest bank, said that house prices would have to fall by 10 per cent a year for two to three years before first-time buyers would be able to afford to get into the market.

In the real world . . .

Hyperinflation What is it? Very fast, very large increases in prices In other words You start to carry your spare cash around in a wheelbarrow

Weimar Republic-style hyperinflation: “Never mind that the currency’s worthless. At least I’ve got my own wheelbarrow!”

Stagflation What is it? A combination of slow economic growth and rising inflation In other words Prices are going up, and we’re earning less and less

Economic slowdownWhat is it? The economy stops growing as quickly as it has been In other words Your neighbour loses his job

Recession What is it? Two consecutive quarters of decline in real gross domestic product (GDP) In other words You lose your job

Explore Economics

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