Government Is Facing Tough Choices on Inflation; ECONOMICS

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Byline: By Nevill Boyd Maunsell Economics Editor

Chancellor Alistair Darling was urged to abandon the Bank of England's two per cent inflation target yesterday after official numbers showed rocketing gas and electricity bills drove the cost of living ahead three per cent over the 12 months to April, up from a seemingly reassuring 2.5 in February and March.

This appears to rule out the prospect of a cut in the Bank's official interest rate next month to counter the credit crunch and a worsening economic slowdown.

Even a 0.1 per cent increase in inflation will require the Bank's governor, Mervyn King to write an open letter of explanation to Mr Darling to explain why the Bank has missed its target by more than one per cent.

To get back to target, the Bank will have to keep rates higher, offsetting inflation arising from world food and energy prices by squeezing British living standards and company profits, warned Peter Spencer, chief economic adviser to the influential Ernst & Young ITEM Club.

"This leaves the Government with an important decision to make over the inflation target," he added. "One option is to stand by the two per cent target rigidly and accept this will mean much weaker economic growth and further undermine the living standards of core Government supporters.

"Alternatively, the Government could make an active choice about the inflation/growth trade-off and raise its inflation target for the next couple of years."

National Statistics reported prices as measured by the Government's chosen consumer prices index jumped 0.84 per cent between March and April, while the longer-running retail prices index went a clear 0.9 per cent higher to record year-on-year inflation of 4.2 per cent, up from 3.8 in April.

Chancellor Darling's Budget increases in wine and spirits taxes compounded the leap in gas and electricity. The outcome would have been worse but for a drop in clothes prices and petrol rising less than it did in April 2007.

The year-on-year increase in the RPI was steeper than at any time since 1992, when living costs were driven higher by the fall in the pound after it crashed out of the Exchange Rate Mechanism the year before.

At Birmingham Chamber of Commerce and Industry, Katie Teasdale, policy adviser, commented: "Many of Birmingham's firms are reporting margins are being severely cut into by inflation, most seriously by rising fuel prices. …