(RTTNews) - UK inflation accelerated more than expected in May, reaching above 3%. Such a move forced the central bank governor to pen an open letter to the country’s chancellor, in which he warned that the rate will rise significantly later in the year. Meanwhile, the central bank chief’s comments were widely interpreted as dovish.

Tuesday, the Office for National Statistics reported that the consumer price index, or CPI, annual inflation accelerated to 3.3% in May from 3% in April, exceeding economists’ forecast of 3.2%. The figure also came in well above the official target of 2%.

Inflation was driven higher by high food and fuel prices. The current rate is the highest since the official series began in January 1997.

The statistical office said that the largest upward contribution came from food and non-alcoholic beverages. Significantly, food inflation shot up to 8.7% from 7.2% in April, led by spiraling meat and vegetable prices. Further, the utility costs surged 11.2%, up from 8.3% in April.

As per official norms, if the inflation rate falls a percentage above or below the official target of 2%, the central bank governor must sent an explanation letter to the Chancellor. The letter is meant to explain how the central bank plans to bring inflation back to target.

This is the second instance when Governor Mervyn King would pen a letter to the chancellor and also the second since the central bank gained independence in 1997. In April 2007, King had written a similar letter to the chancellor, when the key inflation measure for March 2007 reached 3.1%.

In his letter, King attributed the inflation surge over the past couple of months to the unanticipated increases in the prices of food, fuel, gas and electricity. In the coming six months, he expects inflation to rise significantly above the target.

“As things stand,” he said in the letter, “inflation is likely to rise sharply in the second half of the year, to above 4%”. In its May inflation report, the Monetary Policy Committee had forecasted inflation to rise above 3.5% later this year.

That said, King added that there were sufficient reasons to expect the period of above-target inflation to be temporary. He ruled out continuing inflation in the UK economy and said there was no generalized rise in prices and wages resulting from rapid growth in the amount of money spent in the economy

Inflation is expected to peak towards the end of the year and retreat to the target afterwards. However, CPI inflation is expected to remain above the target well into 2009.

King said, “I expect, therefore, that this will be the first sequence of open letters over the next year or so”. In his response to King’s letter, Chancellor Alistair Darling was in agreement to this prediction, saying “Consistent with the remit, the next open letter will not be required until September, if the August inflation figure is above 3%.”

Darling also stated that the government will continue to support the MPC in its the forward-looking decisions to maintain price stability.

In what was construed as a dovish statement in the letter, King said, “the path of bank rate that will be necessary to meet the 2% target is uncertain”. He noted that the central bank is targeting to bring inflation back to target within its normal forecast horizon of around two years, for which a growth slowdown is essential. The governor said, “A slowdown is already in train”.

Volatility in commodity, energy and import prices means that inflation will now be less stable, the Governor noted, adding that it does not mean the rate would remain at a higher level. The central bank will maintain price stability by ensuring that the rise in inflation is temporary, he asserted.

A further break down of the data showed that month-on-month, the CPI rose 0.6% versus 0.8% rise in April and faster than the expected increase of 0.4%.

Meanwhile, the core CPI, which excludes energy, food, alcoholic beverages and tobacco, grew 1.5% year-on-year, in line with expectations and up from April’s 1.4%. On a month-on-month basis, core CPI was up 0.3%, compared to 0.5% in April.

Further, the ONS reported that the retail price index, a benchmark for wage settlements, grew 0.5% month-on-month in May, faster than 0.4% predicted, but slower than 0.9% recorded in the previous month. Year-on-year, the retail price index climbed 4.3%, while consensus forecast was 4.2%. Retail price index excluding mortgage interest payments increased 4.4% over the previous year.

Other inflationary measures have also shown significant increases. Factory-gate inflation in May accelerated at the fastest pace since records on a consistent basis began in 1986.

The latest quarterly survey of Bank of England and GfK NOP showed inflation expectations in UK rose to a new series high. Median expectations of the inflation rate over the coming year climbed to 4.3% in the latest survey from the previous record high of 3.3% in February.

In June, ignoring rising calls for a rate cut, the UK central bank left the key interest rate unchanged at 5% as policymakers focused on accelerating inflation despite concerns over slowing growth. The central bank held the base rate unchanged for the second month in a row after a 25 basis point cut in April, the third since December 2007.

In a note, BNP Paribas economist Raymond Van der Putten said the MPC is not expected to change its position as a result of disappointing inflation data. The economist noted that a rate hike at this time is still unlikely as its damaging impact on the economy might outweigh its beneficial effects on inflation. The economist expects the bank rate to remain unchanged, at least till the end of the year.

The UK economy recorded its weakest pace of growth in three years in the first quarter of 2008 driven by a decline in activity in the business service sector and investment as against robust growth in household consumption. King had said there could be an “odd quarter or two” of negative growth, hinting at the possibility of a technical recession, which is defined as two straight quarters of declining output. The central bank’s projections indicated that annualized growth could slump to as low as 1% this year.

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