Forget about any more UK interest rate cuts

By Associate Editor David Stevenson May 14, 2008

David Stevenson

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Forget about any more interest rate cuts. Inflation is firmly on the agenda. It looks like the pound in your pocket will be losing another hefty chunk of its purchasing power over the coming months. Meanwhile, the economy will crash and burn – but there’s nothing the Bank of England can do about it.

Britain’s consumer prices are set to rise “sharply” higher in the near future, according to the latest Quarterly Inflation report out today from the Bank of England. And looking further out, price increases will only moderate as economic growth tanks, compounding the misery currently felt by homeowners and on the high street.

Of course, none of this will remotely surprise keen students of recent UK inflation history. Or, indeed, regular MoneyWeek readers. Not only did last month’s consumer price index (CPI) hit 3%, according to yesterday’s release from the Office of National Statistics, its highest level for 13 months, but the month-on-month rate surged by 0.8%, the biggest leap since May 2001. What’s more, the old-style RPI (retail price index), which includes mortgage payments, climbed 4.2% on an annual basis.

And the previous day there was the news that both manufacturers’ raw material costs and the price of goods leaving British factories soared in April at the fastest rate since records began in 1986, as food and energy costs rocketed, at 23.3% and 7.5% respectively. All a great deal worse than most of the experts expected.

So the Bank’s admission that consumer prices could soon be advancing at a near 4% clip represents, at least, some semblance of reality. Whether it goes far enough is quite another matter.

Amid all the Bank’s infamous ‘fan’ charts which seem to allow for virtually any possibility going forward, the best bet from the Threadneedle Street thinkers is for the CPI to peak sometime this autumn, than drop back to the official target of 2% by the back end of 2009. That’s despite the admission that “persistently elevated consumer price rises are pushing up inflationary expectations”.

As it is, very few of us have much, if any, confidence in the official inflation figures as a true guide to the cost of living. The relentless rise in commodity prices keeps adding to the pain already meted out by a variety of stealth tax increases, punishing consumers whose incomes aren’t rising anywhere near as fast as their costs.

But looking forward realistically, the real rate of inflation looks set to be several percentage points higher than the Bank’s analysts are suggesting.

It’s going to take one heck of a deep and prolonged recession to slash back demand in the economy sufficiently to meet those ‘central case’ CPI projections. We’re talking about more than just growth shuddering to a complete halt; we’d probably need something closer to a near depression. Of course, that’s not to say it won‘t happen, but the analysts haven’t been disposed to pencil such a scenario into those fan charts.  

Maybe the Bank is trying to talk down future inflation expectations to prevent an upsurge of heavy-duty public sector wage claims. Today’s news that average earnings including bonuses in the three months to March rose 4.0% year-on-year, not only above forecasts but also the highest since last November, won’t have cooled the Old Lady’s brow.

If the Bank were being really honest about where inflation is headed, the rate setters on the Monetary Policy Committee wouldn’t need to spend too long deliberating their next decision. Base rates would be marched straight back up.

There’s not much chance of that. But at least interest rate cuts should be off the MPC’s menu for the moment.

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Published in Economics | More articles by David Stevenson

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