Production costs set to tip UK into 'stagflation'

Staggering leaps in factory-gate inflation had economists reacting in unison: that the figures are appalling, that interest rates are not coming down any time soon and that cost-of-living retail inflation is set to spiral outside of the Bank of England's targets just as growth in economy begins to stall.

The figures will also send a shiver through Downing Street, showing that both fuel and food prices are now running out of control.

The Office for National Statistics today said producer price input inflation - what manufacturers pay to source materials and fuel - is rising at 27.9% a year. This is its fastest rate since detailed data was first collected in 1986.

In a single month, manufacturing costs have surged 3.8%, reflecting an 83% surge in the last year in the price of crude oil and a 25% leap in fuel bills. The cost of home-produced foodstuffs has jumped 31% year on year.

Those costs are being passed on to the retailer. Producer price output inflation - manufacturers' selling prices - has surged by 8.9% year on year, up 1.6% in May alone and again the biggest leap recorded by the ONS.

Petrol and diesel wholesale prices over the year have leapt 28%, while food is being sold to retailers 11% higher than a year ago. "These figures are absolutely appalling and will have dismayed the Bank of England," said Howard Archer, chief UK and European economist at Global Insight. "The abysmal May producer price inflation further constrains the Bank's ability to deliver the interest rate cuts the economy so badly needs."

Jonathan Loynes, chief European economist at Capital Economics, raised the spectre of stagflation - rising prices at a time of falling economic growth. "These data are absolutely horrendous. All the key numbers are far worse than expected," he said

"They are the strongest signs yet that the UK's inflation problem is starting to spread beyond the food and energy sector, with producers' raw material costs having risen by almost 14% over the last year. Most worryingly, producers are continuing to pass on higher costs in their selling prices.

"With cost pressures still soaring it will take further dreadful news on the real economy to prompt the monetary policy committee to cut interest rates again in the near future. The chances of a recession are growing by the day."

Ross Walker, UK economist at Royal Bank of Scotland, said: "Another month, another record rise. The continuing escalation in import costs serves to emphasise the consequences of the weaker pound. The chances of a cut in the Bank rate this year are receding rapidly."

The pound traded 0.75 of a cent up at $1.9775.

Opposition MPs attacked the Government's handling of the economy. "It now seems we're back to 1970s stagflation," said Liberal Democrat shadow chancellor Vince Cable.