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LONDON (Dow Jones)--A jump in inflation to a 14-month high in January forced Bank of England Governor Mervyn King to write to the government explaining the move, but the data highlight factors that are likely to cool price growth significantly ahead.
U.K. annual consumer price inflation accelerated to 3.5% in January from 2.9% in December, marking its strongest rate since November 2008, the Office for National Statistics said Tuesday, but coming in below economists' forecasts for it to hit 3.7%.
That may reflect spare capacity in the economy and the weakness of retailers' pricing power, and underscores the likelihood that monetary policy will stay very loose for some time, analysts said.
"The key point is that the Monetary Policy Committee believes that the rise in inflation will prove to be temporary, and therefore requires no policy response," said Simon Hayes, economist at Barclays Capital. "Inflation is likely to stay above target for several months to come, but given the fragility of the recovery, further policy loosening remains more likely than policy tightening."
The ONS said that January's acceleration in inflation reflected a "quite significant" impact from the reversal of an earlier cut in the sales tax. The initial tax reduction was aimed at kick-starting the U.K. economy, which narrowly emerged from a six-quarter-long recession in the final quarter of 2009.
King also noted the influence of a 70% rise in oil prices over the past year and delayed effects from the sharp depreciation in sterling.
Overall inflation fell 0.2% from December, the ONS said. Core inflation, which excludes volatile energy, food, alcohol and tobacco prices, slipped 0.6% on the month in January, but marked a record high of 3.1% on the year.
In his letter, King said the MPC would tighten policy if it believed it necessary. But he didn't give any indication that the MPC is at all close to mulling such action, pointing out that the committee remains open to extending its purchases of government bonds and other assets if economic conditions warrant extra support.
He stressed that spare capacity is likely to drag inflation back to its 2.0% target in the second half of this year and below it after that.
"January's consumer prices figures should provide some reassurance that, behind the special factors currently pushing inflation higher, underlying price pressures in the U.K. economy remain pretty subdued," said Jonathan Loynes, economist at Capital Economics.
The BOE launched its GBP200 billion quantitative-easing program--through which it has bought mostly U.K. government bonds with freshly created central bank money--in March last year, having slashed its key interest rate to an all-time low of 0.5%.
At its February meeting--the minutes for which will be published Wednesday--the MPC opted to suspend its asset-purchasing policy, but it has made clear that it could restart the program if the economic recovery is slower than it expects.
"The committee is committed to taking whatever actions are necessary to ensure that the outlook is for inflation to remain in line with the 2% target," King said.
The BOE governor is obliged to write an explanatory letter to the government if annual inflation moves more than one percentage point above or below the 2.0% target.
In its quarterly Inflation Report last week, the MPC signaled that it won't tighten policy for at least the next year, and said the impact of expected measures by the next government to reduce its debts is a key reason behind that.
Replying to King's letter, U.K. Chancellor of the Exchequer Alistair Darling made clear that the government recognizes the need for fiscal tightening in the years ahead, which would subdue inflation pressures as the economy recovers.
"Over the medium term, setting a credible consolidation path to ensure sound public finances is a key element of the government's macroeconomic strategy and it is essential for economic stability and the long-term health of the economy," Darling said, adding that in the financial year starting in April 2011, "the focus of the government's fiscal policy shifts towards consolidation."
Whichever party wins a general election due by June 3 will need to take radical action to cut spending, raise taxes or both, with international ratings agencies threatening to remove the U.K.'s triple-A credit rating if the next government doesn't take aggressive steps to put its finances on a sustainable path.
The opposition Conservative Party, which currently leads the polls, has said it would cut spending in 2010, a move Darling has said could undermine the economic recovery.
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