THE Governor of the Bank of England (BoE) warned yesterday that there was a “great deal of uncertainty” over the outlook for inflation, after the rate soared to its highest level in more than two years.

In a letter to Chancellor George Osborne, Mervyn King said inflation was likely to continue rising over the next few months, and admitted there were “real differences of view” among members of the bank’s Monetary Policy Committee.

The Governor’s comments came as the Office for National Statistics (ONS) revealed that the Consumer Prices Index (CPI) rate of inflation hit 4% in January, up from 3.7% in December.

The ONS said inflation was being driven up by soaring commodity prices, such as crude oil, as well as the impact of the VAT rise from 17.5% to 20% last month.

The Governor is required to write a letter of explanation to the Chancellor when inflation has been 1% or more above its 2% target for three months in a row.

In his letter, Mr King said high inflation was down to the rise in VAT, the low value of the pound and rising energy prices.

He said: “There is a great deal of uncertainty about the medium-term outlook for inflation. And I do not wish to conceal there are real differences of view within the committee, reflecting different judgments about the risks to that outlook.

“Inflation is likely to continue to pick up to somewhere between 4% and 5% over the next few months.”

The Governor said the MPC believes that pulling inflation back to target quickly could damage economic growth and would increase the risk of undershooting the 2% target.

Mr King said there was a risk that the high cost of living could increase inflation expectations and thereby pull up wages and other prices.

He went on: “Inflation is likely to remain above target for this year, before falling back in 2012.”

After holding interest rates at 0.5% and the level of quantitative easing at £200bn at this month’s meeting, Mr King said the MPC was “conscious that there are large risks in both directions”.

January's CPI figure, the highest since November, 2008, is double the government's target and is likely to throw weight behind the argument for an interest rate hike.

However, weaker-than-expected growth figures, revealing a 0.5% decline in GDP in the final quarter of 2010, have highlighted the fragile position the economy is in.

The CPI rate of inflation rose by 0.1% on a monthly basis between December and January, the first time since records began in 1997 that prices rose between those two months.

The price of petrol, as recorded by the CPI, hit 127p per litre in January – a record high, according to the ONS.

But rising prices in transport, restaurant and hotels, furniture and alcohol also made significant contributions to the increase in the overall rate of inflation. The City will be looking closely at the BoE’s latest quarterly inflation report, which is published later today, for more clues about when an interest rate hike is most likely.

In response to the Governor’s letter, the Chancellor pointed out that stepping back from the current programme of austerity measures would put upward pressure on inflation.

He added: “For its part, the Government’s commitment to delivering its fiscal consolidation plan continues to provide the MPC with the space it needs to target low inflation.”

Shadow chief secretary to the Treasury, Wallasey MP Angela Eagle, said the Government was partly to blame for the prices surge. She said: “This latest rise in inflation confirms the price rises people have been seeing on the high street and at the petrol pump.

“Families are feeling the squeeze and this has been compounded this month by the Tory-led government’s broken-promise hike in VAT.

“George Osborne has put the Bank of England in an impossible position. It has been left to do all the work to support a halting recovery, while the Government imposes the biggest fiscal tightening of any major economy in the world and is pushing up inflation, too, with its VAT rise.”

Economists called the BoE’s credibility into question as the rate of inflation has now exceeded 3% for 24 of the last 34 months. Neil Prothero, economist at the Economist Intelligence Unit, said: “Having known the CPI figure ahead of last week’s rate decision, the BoE’s official stance will be to continue to blame ‘temporary’ factors of sterling depreciation, the VAT hike and rising commodity prices.

“But with inflation having exceeded 3% in 24 of the past 34 months, the credibility of this argument is wearing thin. A growing number of MPC members may be thinking the same thing.”

Howard Archer, chief UK and European economist at IHS Global Insight, said the figures were a “kick in the teeth” to the Bank.

He added: “This level, and the prospect of further increases to come in the next few months, is increasingly testing the Bank of England’s nerve – and an ever-increasing number of observers suggest its credibility over its argument that inflation will fall back under 2% in 2012.”

Jack Stopforth, chief executive of Liverpool Chamber of Commerce, said: “We believe that a premature hike in interest rates would make no difference to inflation in the short-term, but would put the recovery at risk. It would also make it more difficult for the Government to implement measures aimed at cutting the deficit. Raising interest rates at a time when fiscal policy is being tightened will heighten pressures facing businesses and individuals.”