Awwal 04, 1432 H / April 08, 2011, SPA -- British factory gate inflation rose to a near two-and-a-half year high in March on soaring food and energy costs, data showed, adding a fresh twist to the policy dilemma facing the country's rate-setters, according to Reuters. Sterling strengthened and government bond prices fell as markets took the view that the data increased the chances the Bank of England would raise interest rates next month, after keeping them at a record low 0.5 percent on Thursday. Friday's Office for National Statistics figures showed producer output prices rose by 5.4 percent, their biggest annual gain since October 2008 and confounding expectations of a slowdown to 5.1 percent. The data posed an upside risk to economists' forecasts for March consumer price inflation. The BoE faces a dilemma of whether to raise interest rates at a time when underlying economic growth is weak and inflation pressures may prove temporary, though the current CPI rate of 4.4 percent is more than double the BoE's target. "What the Bank of England is arguing is that a lot of the rise (in producer prices) is not something that policy can do much about," said George Buckley, UK economist at Deutsche Bank. "The question is do you then try to weaken the domestic economy to offset the rise in sterling commodity prices. They probably will have to raise interest rates relatively soon." Buckley added that there was a strong correlation between producer prices and consumer prices, and that there was now an increased upside risk to his above-consensus forecast of 4.5 percent for March CPI data due on Tuesday. Citi economist Michael Saunders took a similar view. "The 2 percent inflation target is not acting as a serious benchmark for companies in their pricing decisions. These strong cost pressures are likely to be reflected in further above-target CPI readings in coming months," he said. WEAK CONSTRUCTION Separate construction industry data also released by the ONS on Friday cast doubt on the likely strength of first quarter GDP data due later in April. BoE policymakers wavering over whether to raise rates have indicated they want to see a strong GDP number to ensure that a fall in fourth-quarter GDP did not mark the start of a sustained period of sub-par growth that could put long-term downward pressure on inflation. Construction output volumes were 0.3 percent lower than a year earlier in February. Citi's Saunders said that the data -- which is not seasonally adjusted -- pointed to construction lopping 0.3 percentage points off the quarterly GDP growth rate. "This could lead to Q1 GDP growth of 0.3-0.4 percent, versus our prior estimates of 0.5-0.7 percent. We stress uncertainties here, but the quirky construction data have played a big role in the repeated surprises in the provisional GDP data over the last year. They may do so again," he said. The disconcerting construction data follows an unexpected sharp monthly fall in industrial output in February -- albeit balanced by an unusually strong survey reading for the much larger services sector. The BoE will also have to take into account that the producer price data suggests there will be upward pressure on CPI for several more months, adding to the risk that firms and households may start to lose confidence in the central bank. Input price inflation eased to an annual rate of 14.6 percent, down from an upwardly revised February reading of 14.9 percent, which was the highest since October 2008. But this was still far higher than the forecasts of 12.5 percent. Stripping out the effect of rising food and petroleum prices, core output price inflation slowed slightly to 3.0 percent from 3.1 percent, again a slightly bigger number than economists had expected. Crude oil prices jumped 9.8 percent on the month, their biggest rise since March 2010, and are now more than a third higher than a year ago. Domestically produced food costs were 13.0 percent more than a year ago.
