MERVYN KING need not write to Alistair Darling just yet.
Bell Ross WatchFigures today show inflation hit 2.9% last month -- up from 1.9% in November and well above the 2% target set by the Government.
It was the biggest monthly jump on record, driven by higher fuel prices and less discounting on the High Street in the build-up to Christmas 2009 compared with the previous year.
Petrol prices edged 0.2p higher in December compared with a fall of 6p a year earlier. Clothing and shoe prices fell by less than a year ago when the temporary VAT cut was introduced and shopkeepers were forced into early sales to tempt shoppers during the worst of the recession.
"A very nasty shock," is the verdict of Howard Archer, chief UK economist at IHS Global Insight. "This will not go down well at the Bank of England."
But inflation has not yet topped 3%, the level at which the Governor of the Bank of England must write to the Chancellor to explain himself.
The return of VAT to 17.5% from 15% on 1 January means that could happen this month. It poses a major dilemma for King and his colleagues on Threadneedle Street.
As the recession deepened in late 2008 and early 2009, the Bank slashed interest rates to a record low of 0.5% and launched a Pounds 200 billion moneyprinting programme to stimulate demand, drive economic recovery and stave off deflation.
That Pounds 200 billion runs out in the next few weeks, and the monetary policy committee must decide its next move early in February.
If the Bank leaves the stimulus in place for too long it risks creating another asset price bubble and driving inflation even higher. If it withdraws it prematurely the economy could plunge back into recession.
The Bank reckons the current spike in inflation will be short- lived and will fall back below target later this year, suggesting it is in no rush to put the brakes on just yet.
Prada Handags ReplicaHowever, with the economy pulling out of recession, albeit slowly, and inflation back above target at least for now, it will be reluctant to pour yet more money into the system.
Many in the City believe the Bank will pause for breath at its next meeting on 4 February, leaving rates unchanged and Pounds 200 billion of quantitative easing in place.
Hetal Mehta, senior economic adviser to the Ernst & Young Item Club, says: "Looking to next month, the impact of VAT being back at 17.5% could push inflation above 3%. But we do not anticipate any tightening of monetary policy to dampen this short-term phenomenon, as beyond January inflation should continue on a downward path well into 2010."
Not everyone is so sure, and the pound is on the rise again on speculation that interest rates may rise faster than expected.
Jonathan Loynes, chief European economist at Capital Economics, says: "December's figures will do nothing to ease the recent increase in inflation worries, but they should not panic the MPC. We expect the MPC to look through the rise in inflation and leave policy unchanged. Still, with inflation set to rise to 3.5% or above in January -- triggering a letter from Mervyn King to the Chancellor -- inflation nerves will be tested in the next few months."
It is a delicate balancing act that King must get right. His success in doing so will be vital to how the Bank is viewed by
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