UK inflation jump will force explanation from BoE

LONDON (Reuters) - British consumer price inflation is expected to have jumped to a 15-month high of 3.5 percent in January, but the news is unlikely to shift the Bank of England's view that this is a transitory surge which will soon fade away.

Retail price inflation in January is expected to show an even bigger similar increase, rising to 3.8 percent -- its highest level since October 2008 -- from 2.4 percent.

Most economists also believe the rise in year-on-year inflation will be short-lived, and largely mirrors developments a year or more ago when oil prices fell sharply, only to rise, and value-added tax was temporarily cut.

Nonetheless, BoE Governor Mervyn King will have to write a letter of explanation to finance minister Alistair Darling if inflation exceeds 3 percent -- as expected by all 30 economists polled by Reuters last week.

Consumer price inflation in December jumped to 2.9 percent.

In the letter, King will probably refer back to last week's quarterly Inflation Report, which had a central forecast that inflation would fall below 1 percent by the end of the year.

Very slow growth while the economy edges out of its worst recession in over 50 years gives firms little scope to raise prices, and means workers are in a poor position to negotiate pay rises, the BoE said.

The view that inflation will not spiral out of control -- even if it remains higher than in the United States and the euro zone -- is shared by many economists.

Darling is highly unlikely to urge the BoE to tighten monetary policy, given the government is keen to support growth before elections due by June, and has already tightened fiscal policy by returning VAT to 17.5 percent on January 1.

"Underlying price pressures should be contained by substantial excess capacity, muted recovery, wage moderation and the need for retailers to price competitively in the face of still limited consumer spending," IHS Global Insight economist Howard Archer wrote in a note to clients.

Economists scaled back forecast interest rate rises after Wednesday's Inflation Report, and now see just one quarter point rise in the last quarter of 2010, taking rates to 0.75 percent.

But not all economists are so relaxed about inflation, especially as CPI came in above consensus for the past two months, and even the BoE sees a risk that it could peak as high as 4.5 percent in the current quarter.

Citi economist Michael Saunders said half of BoE Inflation Reports since 2004 had forecast that inflation would return to target over the coming year, yet almost all had been wrong.

"We still forecast a larger and longer CPI overshoot than the consensus and MPC expect, mainly reflecting lagged effects of the recent surge in import prices," he said.

Inflation has already risen faster than most economists and the BoE expected since it hit a five-year low of 1.1 percent in September -- though Archer said that suggested that most of sterling's fall to a record low at the end of 2009 had now passed through into prices. Sterling has since strengthened.

Nonetheless, there is plenty of scope for market turbulence if inflation does come in above expectations.

Last month the March gilt future dropped a full point after CPI came in 0.3 percentage points above forecast, and in December futures also underperformed, falling to a one-month low in thin volumes after a similar surprise.

Sterling meanwhile strengthened by a third of a penny against the euro to reach a four-month high after January's data.

(Editing by Susan Fenton)