My current projection shows annual consumer price inflation above 3% between July 2008 and January 2009, peaking at 3.5% in September. This is based partly on an assumed further 10% rise in household electricity and gas tariffs. Recent press reports have, however, suggested a much larger rise in retail energy prices.

The chart below shows the CPI component covering “electricity, gas and miscellaneous energy” together with 12-month moving averages of wholesale natural gas and oil prices. The averages remove volatility and seasonal influences and are a reasonable guide to the trend in suppliers' purchasing costs. They have been projected forward assuming prices remain at current seasonally-adjusted levels.

The moving averages peaked in mid 2006 and fell significantly to a trough in the third quarter of 2007. Household tariffs followed, topping in February 2007 and reaching a low last October. Wholesale gas and oil prices have since surged: if current levels are sustained the 12-month moving averages will be 50-60% above their 2006 peaks by early 2009.

The CPI component rose by 11.9% between October and March but is only 1.9% above its February 2007 peak. Recent experience suggests pass-through from wholesale to retail prices of between a quarter and a half. This suggests a further rise in household tariffs of between 10% and 25% will be needed if current wholesale prices are sustained.

A rise of 25% rather than 10% in retail energy prices would result in a mechanical boost of 0.5 percentage points to annual CPI inflation in late 2008 and early 2009. The actual impact would be smaller because the implied squeeze on consumer spending would slow price rises for other goods and services. Even so, the scenario could involve headline inflation peaking at close to 4% and remaining above 3% for as long as nine months, necessitating three explanatory letters.

I am sticking with a 10% figure for the moment, partly on the view that current wholesale prices may not be sustained. Next week’s May Inflation Report will reveal the assumption used by the MPC. Inflation projections could be revised up by more than the market expects, raising doubts about the scope for interest rate cuts.