Price rises - the start of Gordon's nightmare

There is no doubt that inflation is back with a vengeance. Indeed the retail price index, which is the old measure still used by many as the more accurate guide to what it costs to live in the UK, is even higher, standing currently at 4.3 per cent. Nor is there any doubt that people are feeling the squeeze because wages are not rising anywhere near as fast as prices. The pay specialists Industrial Relations Services reported this morning that pay awards across the economy are running at 3.2 per cent. Though that seems quite close to the going inflation rate, it is a false comfort. Pay increases attract income tax and national insurance, so the actual money people have to take home to spend is at least a fifth lower.

At the same time, other calculations show that the proportion of that takehome pay which is eaten up by essentials - mortgage payments, fuel bills and the like - has increased significantly, so for most people there is notably less to spend on the good things in life. That - and the miserable summer so far - is why so many feel so grumpy.

But fun though it may be to blame the Government for everything, in this case it is not really its fault. It is a powerless to inf luence the economic weather as it is the real weather, because the influences which are driving our prices higher are almost all coming from overseas. In the 12 months to May, world agricultural prices increased by 60 per cent, which alone have delivered an eight per cent rise in UK food prices. At the same, time oil prices rose more than 80 per cent, which has put 20 per cent on the price of fuel at the pumps; a 160 per cent increase in wholesale gas prices has added 10 per cent to the average household electricity and gas bill.

When domestic prices have gone up - for example for things like transport - it is because they, too, have been hit by these higher imported costs. And on top of all that the pound has dropped by almost 20 per cent against the euro in the same period, which makes most things coming from Europe more expensive. Going on holiday there this summer will be a nasty shock to the wallet.

However, we should be grateful for small mercies and say a silent thanks for sterling's continued strength against the dollar. Without that the increase in the price of oil and many other things would have been even more painful. And it means it is still cheap to go to Florida's Disneyworld - though you may feel you get enough Mickey Mouse behaviour at home.

Inflation has also hit overseas. We may think our inflation is bad - and it is - but it is better than in most other countries. In May, inflation in the euro area rose to 3.7 per cent, in the United States 4.2 per cent and in the Asian countries, where most of the world's growth is currently taking place, inflation is getting to be not far short of double figures. So by that measure the authorities have done a rather better job at keeping the lid on things here - not that they will get any credit for it, and not, to be honest, that it is much of a comfort.

All over the world, the ingredients are the same. In essence the world has never had so many economies growing so fast at the same time and quite simply the global economy is overheating - not in the global warming sense, though that, too - but in the sense that there is too much demand for raw materials which are in limited supply. Hence the pressure on the price of oil and food and copper and steel. So many more people in hitherto poor parts of the world have money now - there are 300 million middle-class Indians, for example, more than the entire population of the United States - and they want to spend it.

The result is that too many people and companies and governments are trying to buy at the same time and there is not enough supply. For the first time the world is beginning to bump against some natural limits on growth - a problem which will turn out in time to be an even bigger worry than today's inflation. Indeed, what we are seeing is these key commodities rising sharply in price relative to other things that are less in demand and therefore less prone to these sharp increases.

The Bank of England's control over interest rates is a pretty blunt measure when faced with problems like this, because even if it slows the UK economy, that alone will make little difference to these overseas prices. What a weaker economy and lower confidence will do, however - or at least this is the hope - is reduce people's willingness to ask for more money, and companies' ability to pass on price rises. In that scenario, the first round of higher prices, in the shape of imported oil, would not create a second round of higher prices caused by domestic wage and price rises, which would in turn set off an inflationary spiral from which there would be no escape.

That is what happened in the 1970s and it is what the authorities today are most anxious to avoid. They have a fight on their hands, however, for the Bank itself expects inflation to rise to over four per cent later this year, before it starts to tail off again.

But even if higher prices do not feed wage inflation, we are in for a gloomy few months while these first-round effects work through the system. A successful fight against inflation requires that we do not get pay rises sufficiently large to compensate. And this is where the Government does have to take some blame. Other countries can ease the pain for consumers at this stage in the cycle by giving them tax cuts which boost their income without giving them an inflationary pay rise. Our government can't do that because it has blown all the money, leaving the public finances too fragile to finance any handouts. Indeed, though he will certainly not admit it, Alistair Darling's real nightmare may not be inflation at all - but the prospect that he might have to put up taxes next year as the economy slows down.