Britain's inflation problem isn't going away
By
Associate Editor
David Stevenson Feb 16, 2010
Print this article
Is Britain's inflation problem really so bad? The UK consumer price index (CPI) rose by 3.5% in the year to January. But some forecasters had been fretting about the annual rate hitting 4%. And the cost of living actually fell 0.2% month-on-month.
And to be fair, Bank of England boss Mervyn King – the man who's meant to be in charge of controlling the country's cost of living - had already warned us that CPI inflation would climb above 3% soon.
It's just a "temporary" surge, he tells us. CPI will soon drop back below 2% because there's plenty of 'slack' in the economy – the so-called 'output gap'. This would prevent firms raising their prices.
I'm not so sure. Here's why I'm worried.
First, don't be fooled by CPI falling by 0.2% last month. That's what happens in January - prices fall as retailers dump their unsold Christmas stock. In fact, the average January fall over the last four years has been 0.7%.
Second, the Bank's forecasting record is, well - to be kind - rather average. As Michael Saunders at Citigroup points out, "last May, the MPC forecast that CPI in the first quarter of 2010 would be 0.8%; now they expect it to be 3-3.5%. Since that May forecast, sterling oil prices are up £10 a barrel, nothing like enough to add 2.5% to inflation".
Third, that output gap. There's a lot of guesswork involved here, but several economists reckon the Bank's overestimating this. If they're right, firms will have more scope to hike prices than Mr King thinks.
Fourth, longer-term, inflation is like a nasty rash - it's very irritating and extremely hard to get rid of. January's year-on-year CPI figure was boosted by VAT going back to 17.5% and higher petrol prices. But when these drop out of the equation, another problem is likely to crop up. And even 'core' inflation, which strips out the volatile bits, is now at 3.1%. "There are fears that if inflation remains high for too long, it could prompt a call among workers, many of whom face another year of pay freezes, for more generous pay deals", says Robert Lindsay in The Times. "That could spark a damaging wage-price spiral and fuel a more permanent rise in inflation".
Fifth, we've yet to see the full damage filter through from the weak pound. This pushes up the cost of imported goods, which will mean higher prices in the shops.
Sixth, there's the housing market. Like it or not, prices are heading up at the moment. And we've seen in the past how increasing property prices can translate into a higher cost of living.
Whatever the Bank is saying now, it all points to interest rates going up sooner than many people think. Here's an updated version of a Bloomberg chart that we've published before.
The blue line is the base rate and the red line shows CPI, both since 1992. If inflation doesn't drop back again soon, as Edmund Conway has said in The Telegraph, "the case for tightening policy gets ever stronger". In other words, the Bank will have to raise base rates. And that will result in variable mortgage rates being hiked, too. The latest CPI figures mean that switching to a fixed rate looks an even better idea than it did before.
Published in
Economics
| More
articles
by
David Stevenson
Related articles
-
By Matthew Partridge, May 24, 2012
-
By Merryn Somerset Webb, May 22, 2012
-
By Merryn Somerset Webb, May 21, 2012
-
By Merryn Somerset Webb, May 21, 2012
FREE - MoneyWeek's daily investment email
Our free daily email, Money Morning, is an informative and enjoyable analysis of what's going on in the markets. Written by our Editor, John Stepek, and guest contributors.
Sign up FREE to Money Morning here.