Inflation could hit 5% 'within months' as salaries fall and cost of living soars

The prediction comes as economic confidence on both sides of the Atlantic takes a turn for the worse, with new fears for the stability of the global financial system.

The rise reported yesterday means inflation has more than doubled since Labour came to power in May 1997, when it was 1.6 per cent.

Increasing costs: Economic confidence has taken a dive on both sides of the Atlantic

Meanwhile, economists predicted that the cost of living will keep on rising and interest rates will not come down.

To make matters worse, the average worker's pay rise of 3.2 per cent amounts to a pay cut.

The Consumer Price Index, the Government's preferred measure of inflation, shows that 'essential' items, are rising the fastest. Over the last year, the cost of eggs has risen 37.1 per cent, butter 31.5 per cent, beef 17.6 per cent and bread 16.8 per cent. In June, the average price of four pints of milk rose 10p.

The Office for National Statistics, which compiled the figures, said it has not witnessed such a dramatic increase in food and soft drink prices, up 9.5 per cent, since records began almost 20 years ago. A household which spent £100 a week on food last year now needs to find another £18 a week, or £936 a year.

However, the Daily Mail's Cost Of Living Index shows that prices are rising even faster, with butter up 62 per cent, eggs up 46.5 per cent.

According to the CPI, the price of petrol and diesel leapt 24 per cent over the last year, the biggest hike since records began. The price of heating oil has gone up 88 per cent.

Meanwhile, figures from AA insurance show that the average cost of comprehensive motor insurance has broken through the £700 barrier for the first time.

The price of cover jumped by £20 during the three months to the end of June to £702.47. That is nearly six per cent higher than a year earlier.

There are some items which are cheaper than last year, the ONS found. Shoes and clothes are down eight per cent. Vodka is also cheaper. Digital cameras and DVDs are also falling in price, but not as sharply as they were last year.

The CPI measure of inflation has never risen so quickly, the ONS said. In January, it was 2.2 per cent. It has jumped to 3.8 per cent, including the unprecedented two half-point jumps in April and June.

Many are sceptical of the index as a measure of inflation, because it excludes costs such as mortgages, council tax and the TV licence.

LibDem treasury spokesman Vince Cable said: 'Even this rose-tinted measurement of inflation is now showing the huge strain that soaring food and fuel costs are putting on household budgets.

'We are now facing the start of an economic climate worryingly reminiscent of the Seventies, with falling demand, rising unemployment and rising inflation.'

Shadow Chancellor George Osborne said: 'The official figures have caught up with everyone's real experience of rising prices and a higher cost of living.'

Mervyn King, governor of the Bank of England, recently warned that inflation will rise 'above four per cent' in the next few months.

This is double the Government's target of two per cent, but he admits there he is little he can do to stop the price rises.

Jonathan Loynes, of the consultancy Capital Economics, warned it could hit five per cent in the autumn. If a 'double-digit' rise gas and electricity bills is introduced, as is feared, the cost of living could rise to this level, he said. 'Overall, then, things continue to go from bad to worse for the UK economy.'

And Bank of England policymaker, Andrew Sentance warned there will be no respite from rising energy and food prices.

'Inflation is being pushed up in the short term, and it will take time to get it back under control,' he said.

Rising inflation also gives savers a headache. Those who are higher-rate taxpayers need to earn interest of more than 7.67 per cent to keep up with inflation because of the tax bill they must pay.

There are currently no instant or easy access accounts that pay high enough rates, said financial information firm Defaqto.

Dearer BA fares

British Airways is to put up fares and cut flights, bosses have warned.

Ticket price rises of four per cent are 'absolutely inevitable' as fuel costs rise - and one in 20 flights will go, chief executive Willie Walsh warned.

Extra fuel surcharges may be brought in, he added. Jobs could also be threatened.

At BA's annual meeting on Monday, chairman Martin Broughton said the airline is 'up to our necks in perhaps the biggest crisis the aviation industry has ever known'.

Budget airline Ryanair is also cutting flights because of oil costs.

Oil gets cheaper

Oil prices tumbled in New York yesterday amid concerns that the U.S. economy is so weak that consumption of oil is likely to fall.

Traders dumped the commodity so that at one point during the day prices dropped more than $10 a barrel. The price of light crude rose as high as $146.73 and then fell to $135.92.

By the end of the day it had risen again to $143.80, slightly below Monday's closing price of just over $145.

Prices have swung violently in recent days. U.S. government data shows high pump prices and a weak economy have discouraged driving.