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How High Will Britain's Inflation Go?

UK inflation hit a two and a half-year high Tuesday and experts are saying it is only a matter of time before it goes even higher.

Governor of the Bank of England Mervyn King
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Governor of the Bank of England Mervyn King

So how high will it go? Mervyn King, Governor of the Bank of England, warned last week that consumer price inflation could soar above 5 percent later this year.

That figure would be substantially higher than the Bank’s target of 2 percent and it would be for that first time it would go above 5 percent since peaking at 5.2 percent in September 2008.

The Bank’s Monetary Policy Committee has so far resisted pressure to raise interest rates from their historic low of 0.5 percent to help combat rising inflation.

Analysts agree with King that the medium-term rise in inflation this year has been driven by commodity prices and the cost of oil.

As commodity prices have slipped from the heights scaled earlier this year, many expect that inflation will start to fall later this year or in early 2012.

The Bank predicts that it will stay above the 2 percent target until 2013.

The increase in Value Added Tax (VAT) to 20 per cent in January has also helped fuel inflation.

Analysts believe that the effect of the VAT increase on prices will have dropped out of the annual rate of inflation by next year.

“Although inflation will rise further over the coming months as past rises in energy and agricultural prices feed through, we still expect it to fall sharply next year,” Vicky Redwood, senior UK economist at Capital Economic, told CNBC.com.

The UK employment market is still unpromising, and the average wage has not risen as quickly as inflation.

King warned last week that union demands for pay deals to keep pace with inflation could turn one-off shocks such as rising gas prices into a longer-term problem.

April’s spike in inflation was driven by rising transport prices and the late Easter holiday.

Air, sea and rail travel on their own added 0.4 percentage points to inflation, while core goods inflation actually rose very slightly, from 1.8 percent to 1.9 percent.

Duty on alcohol and tobacco also rose after the most recent Budget, further squeezing UK consumers’ budgets.

“It is evident that there were different timings in the seasonal rises in some prices due to Easter occurring much later in April in 2011 than in 2010 that held down inflation in March but pushed it up in April," Howard Archer, chief UK and European economist at Global Insight, said.

"Air transport was the most obvious example,” Archer added.

“Given the distortions caused by the different timings of Easter in 2010 and 2011, it is probably most meaningful to look at the overall inflation picture for March and April - this shows inflation edging up to 4.5 percent in April from 4.4 percent in February,” he added.

Archer expects inflation to hit 5 percent as soon as September.