UK inflation slows, BoE must still explain overshoot

British consumer price inflation slowed in July but as expected remained above 3%, forcing a third open letter from the Bank of England this year to explain why inflation is still above target.
The Office for National Statistics said that the annual CPI rate slowed to 3.1% from June's 3.2%. That was the lowest since February but the eighth consecutive month that it has exceeded the BoE's 2% target.
Gilt futures were little moved on the data, which is broadly in line with the slowdown implicit in the BoE's quarterly Inflation Report published last week, and boosts expectations that the BoE will keep interest rates on hold well into 2011.
"The Governor will be able to play down these figures. Were it not for January's VAT rise, then inflation would most likely be below target," said Andrew Goodwin, senior economic advisor to accountants Ernst & Young.
Under the BoE's remit, Governor Mervyn King has to write an open letter to the government when inflation is more than 1 percentage point above or below target. He then has to write a new letter if inflation is still more than a percentage point away from target three months later.
King has previously written letters in February and May this year and each time blamed one-off factors for the overshoot, such as a Jan. 1 rise in value-added tax as well as a jump in oil prices and sterling weakness.
He will likely blame these factors again when the letter is published at 0930 GMT, and repeat his belief that inflation will fall below its 2% target within two years.
The ONS said that the biggest downward effect on CPI inflation in July came from transport costs, particularly the prices of second-hand cars and fuel, reducing the annual rate by 0.14 percentage points.
There was also the sharpest clothing discounting for this time of year since 2002, reducing the annual CPI rate by 0.11 percentage points.
However, rising prices for food and non-alcoholic beverages added 0.16 percentage points to CPI, with the largest upward effect from vegetables.
Less discounting in the furniture and household goods sector than last year also pushed up the annual CPI rate, adding 0.06 percentage points.