Bank of England: Inflation Report August 2007

In the United Kingdom, the recent brisk pace of output growth was sustained in the second quarter.

There were tentative signs of a slowing in consumer spending. Business investment fell back modestly, but was substantially higher than a year earlier. The pace of global expansion remained rapid. In late July, credit spreads widened internationally and equity prices fell. Under the assumption that Bank Rate follows market yields, the Committee’s central projection is for output growth to fall back to a rate closer to its long-run average.

Ted Scott, manager of F&C UK Growth & Income Fund, comments on the latest quarterly inflation report by the Bank of England: "The most important message from today's report is that the Monetary Policy Committee does remain concerned about inflation. There is no reason to think interest rates have peaked yet and there will probably be another quarter of a percentage point rise before we reach the peak of the cycle. Having said that, the inflation report shows that the tighter monetary policy is beginning to have an effect on the consumer.

Over the last few years the consumer has certainly been supported by the buoyant housing market and there are now increasing signs of the housing market slowing down. Other factors such as oil prices reaching record levels and food price inflation are putting more pressure on consumers.

Food price inflation has been a real feature of this summer, aggravated by floods and extreme weather events both in the UK and overseas. Prices for basic goods such as milk, fruit and vegetables have gone up noticeably and therefore the CPI is actually understating the current real inflation rate for the consumer in terms of discretionary income.

Unlike in previous years where higher food prices were offset by lower prices from other retailers, current food price inflation is not being offset by deflation on the high street. In the last 5 to 10 years prices for goods such as clothing and electronic items went down significantly as a consequence of cheap labour and low manufacturing costs in the Far East. We are now witnessing the impact of rising manufacturing costs in China on high street prices.

Today's report acknowledges consumers are starting to feel the squeeze. We are approaching the peak of the cycle but we are still likely to see another rise in interest rates over the next few months."