Why UK inflation figures are warning of a double-dip recession
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MoneyWeek Editor
John Stepek Nov 18, 2009
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Mervyn King: may soon be apologising
Many of the biggest economies in the world are wrestling with deflation. The US, Japan, even Europe – in all of these regions, prices are either flat or falling.
Not in Britain. In the UK, we don't suffer the dreadful blight of falling prices. No, for us lucky Brits, the cost of living just keeps on rising. Aren't you glad?
Well, perhaps if you're up to your eyeballs in debt, it's not so bad. But if you're a pensioner living on a fixed income, or you prefer saving to spending, you're in trouble.
So how much higher will inflation go? And what does it mean for you?
What's driving the inflation rate up?
Britain's annual inflation rate rose for the first time in eight months in October, ticking higher from 1.1% in September to 1.5%, using the consumer price index (CPI) measure. As usual, this was more than analysts had expected (they'd plumped for 1.4%).
That's not far off the Bank of England's central 2% target. And for the next few months certainly, it's only likely to keep rising. Some pundits even reckon that the next letter Mervyn King writes to the Chancellor will be to apologise for CPI going above 3% a year, rather than to explain why Britain's stuck in deflation.
So what's driving the gains? Well, you do have to bear in mind that this time last year, prices were falling pretty sharply. So for example, even although fuel prices actually dipped a little month-on-month in October, they're still up on this time last year. There are also price hikes resulting from companies slashing back capacity. Air fares rose a little this year, after plunging last year.
But as Edmund Conway points out in The Telegraph, probably the biggest driver behind British price rises has been the weak pound. Forget about Black Wednesday, when Britain was kicked out of the Exchange-Rate Mechanism (ERM) in 1992. "Sterling's 25% fall since the onset of the crisis is certainly the biggest since the UK left the gold standard in the early 1930s".
This of course, drives up the prices of imported goods. Over the year, the prices of goods (which are mainly imported) rose by 0.8%, whereas services inflation (which is mainly domestically produced) came in at its lowest point since records began 12 years ago. The likes of DVDs, computer games and toys saw prices increase. The price of food went up too.
There was also a massive rise in the price of second-hand cars, which presumably is partly a reflection of the hit they took during the financial crisis, and also partly down to the 'cash for clunkers' scheme decreasing the supply of second-hand vehicles.
We're headed for a double-dip recession
So what does this mean? Are we going to spiral off into hyperinflation any day now? I have a lot of sympathy with the argument that we'll see rapidly rising inflation at some point in the future. And I think that inflation will be much stickier than most expect. However, I'm not sure rampant inflation is coming right away.
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The core problem is unemployment. As long as companies are cutting jobs and there's a large pool of people out there looking for work, then employees are left in a pretty poor bargaining position. That's nice for corporate profits on the cost-cutting side, at least in the short-term. But it's not so good in the long term. If people's wages aren't keeping up with their cost of living, then they have less disposable income to spend. That means they cut back, which means companies lose sales.
This hasn't been an issue so far this year. Part of the reason that the economy hasn't suffered as badly as it might have, is because the cost of living has been falling for many people. If you kept hold of your job, and you have a home loan and a car or two, then your disposable income probably rose in 2009. Your salary may not have budged much, but petrol prices came down sharply, as did home loan costs for many people.
But that's all in the past now. Home loan costs have fallen by as much as they're going to. From here the only way is up. And petrol prices, despite what seems to be an indisputable glut of oil on the market, are a lot higher now than at the start of the year.
On top of that, other little costs are ticking higher. The price of both house and car insurance is rising again. And in sectors where companies are facing fewer competitors or have managed to slash back capacity – such as household furnishings, or air travel – prices are edging higher too.
To me this all points in one direction – a double-dip recession. As consumers start to see their costs rising again, they'll have to trim spending harder. That in turn will make it harder for companies to raise prices, which will probably help to keep a lid on inflation for now, but will hurt their profit margins. It's called 'stagflation', and it's not very pleasant.
How to protect yourself from rising prices
Meanwhile, the Bank of England will be keeping interest rates as low as it can for as long as possible. So savers are really going to feel the pain – on the one hand they'll be stuck with higher costs, and on the other they'll have dreadful returns on their savings. So it's more important than ever that you make sure your savings account is paying you the best rate. For more on this, and other personal finance matters, you should sign up for my colleague Ruth Jackson's free weekly personal finance email, MoneyWeek Saver if you haven't already. And for Ruth's latest piece on savings rates, have a look here: The best one-year savings product.
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