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. 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. 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.
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. 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. 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.