Bank chief baffled as inflation rate remains stuck above 3pc

The comments came in his open letter to Chancellor George Osborne as inflation edged down to 3.1 per cent in July, but remained stuck well above the Bank's 2 per cent target.

Rising food costs offset the impact of falling petrol prices over the month on the

Consumer Prices Index (CPI), which the Bank expects to stay above target until the end of next year.

The Governor said: "How fast and how far inflation will fall are both difficult to judge with substantial risks in both directions."

The Bank, which has faced criticism over its forecasting in recent weeks, lowered growth predictions in its quarterly report last week and said inflation would be higher than first thought.

The Governor said the huge economic slack created by a record recession was being masked by January's rise in VAT, high oil prices and sterling's weakness pushing up import prices. The looming rise in VAT next year will add to inflation pressure.

He also underlined his warnings of a "muted" recovery not strong enough to close the gap created by the slump, eventually dragging inflation below the target.

Chief European economist with Capital Economics Jonathan Loynes said the majority of the bank's rate-setting committee were "likely to remain comfortable" with record low interest rates to boost the economy for some time to come.

Senior economic advisor to the Ernst & Young ITEM Club Andrew Goodwin added: "Earnings growth remains below two per cent and it is difficult to make a case for inflation taking off without a response from wages – in the current climate, with unemployment remaining high and public sector job losses on the way, the scope for workers to push up wages is very limited."

The Office for National Statistics (ONS) figures showed a 0.7 per cent jump in food prices between June and July – the biggest monthly rise for two years – driven by higher costs for meat, fruit and vegetables contrasting with price falls a year earlier.

But falling petrol costs and second-hand car prices over the month dragged down the overall price index, as motorists enjoyed an average 0.7p a litre fall over the month against a 1.1p rise at the forecourt a year earlier.

The squeeze on food shopping bills also contrasted with the picture on the high street, where retailers are still cutting prices to draw in worried consumers.

The ONS said clothing and footwear prices fell 4.9 per cent between June and July – the biggest price slide in a single month since 2002. But rail commuters will be braced for fare rises of almost six per cent next January.

Tory chairman of the Commons Treasury Select Committee Andrew Tyrie said the overall situation had to be monitored to ensure inflation did not become entrenched.

He said: "What I think we have got to do is monitor this extremely carefully and bear in mind that we cannot afford to take risks with inflation while at the same time recognising monetary policy is very loose, it needs to stay loose.

"We have got interest rates at 0.5 per cent, the Governor is making clear that they have got to stay there until we make sure that we have got a recovery deeply entrenched."

The latest dip in inflation offers little comfort to savers who are still struggling to earn a real return on their money.

In spite of the slight fall in inflation, basic rate taxpayers still need to earn a return of at least 3.88 per cent on their money to stop the value of their funds falling in real terms, once tax and inflation are taken into account.

Higher rate taxpayers face an even steeper challenge, needing to earn interest of at least 5.17 per cent to stop their savings losing their value.

The problems savers face in beating inflation are also unlikely to improve in the near future with inflation expected to remain elevated throughout 2011.

[email protected]