UK inflation: why interest rates will stay frozen for now
By
Associate Editor
David Stevenson May 13, 2008
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Following Monday’s news of record rises in factory gate prices, this morning we learned that the UK’s headline inflation rate jumped dramatically in April. The news shocked the markets and knocked 100 points off the FTSE 100 index.
The Consumer Price Index (CPI) hit 3%, according to the Office of National Statistics, its highest level for 13 months. The monthly increase reached 0.8%, the biggest leap since May 2001.
The numbers might have shocked the experts, but the man or woman in the street probably won’t be too astonished. Several recent surveys have suggested that the real inflation rate for those who don’t spend all their spare time buying new gadgets, but have to refuel the car to visit the supermarket after paying their electricity and council tax bills, is still some way higher than the official numbers have been indicating.
But it seems that the official data may finally be starting to reflect reality. And both the old-style RPI (retail price index), which includes mortgage payments, and RPIX, rose sharply, posting annual increases of 4.2% and 4% respectively.
Where does this all leave the Bank of England’s Monetary Policy Committee, busily cutting base rates since last December despite this inflation build up?
Confused? Embarrassed? Well, to be fair, Governor Mervyn King has been dropping hints for some time that he’s been sharpening his pencil to write the obligatory explanatory letter to the Chancellor should the CPI exceed 3%. That hardly exonerates the Bank in effectively ignoring price pressures for the sake of the trying to appease the Government and consumers.
One thing’s for sure - the MPC will remain under pressure from businesses, politicians and estate agents to cut rates, as the rest of the economic data out this week so far suggests the UK economy is heading down the drain fast.
The British Retail Consortium said that annual sales growth on the high street is at its lowest in three years. Meanwhile, the latest data from the Council for Mortgage Lenders (CML) showed that just 46,000 mortgages for new home purchases were approved by banks and building societies during March, down from 89,000 last year. That came on top of the news from the Royal Institution of Chartered Surveyors (RICS), that the UK housing market is now in its worst condition for 30 years as a record number of estate agents reported falling property prices.
Simon Rubinsohn, chief economist for the RICS, said that completed sales are 'falling off a cliff'. CML director general Michael Coogan cautioned the declines are set to continue over coming months. The only silver lining apparent to him right now is that since the introduction of the Bank’s Special Liquidity Scheme, there’s been a slight improvement in the credit markets, with LIBOR rates (at which banks lend to each other) moving a bit lower. Unfortunately for Mr Coogan, even LIBOR’s gone up today.
On top of all that, even the Government has now admitted that house prices look set to fall. The Telegraph reported today that Housing Minister Caroline Flint emerged from 10 Downing Street today carrying her official briefing notes which could be seen by waiting photographers.
Apparently she told her Cabinet colleagues that she now expects house prices to fall by between 5 and 10% this year “at best”, admitting that “we can’t know how bad it will get” with house-building “stalling”.
Yet the truth is that regardless of what happens with interest rates, the housing market can’t be saved. Banks don’t like lending against depreciating assets, and that means that the days of no-deposit down, 100% interest-only mortgages are long gone.
The MPC should now be firmly focusing on preventing inflation from getting even worse. Amid all the rate cutting, sterling has been plummeting against the euro, compounding the rising cost of imports. March imported goods prices leapt by 1.9%, lifting the annualized rate to 10.3%. First quarter import prices for goods excluding oil and erratic items were up by 5.8% year-on-year - the biggest quarterly gain since 1995.
And with inflation about to burst through the CPI target, surely the Bank can’t be planning further rate cuts for the moment? We’ll soon find out - tomorrow, it’s publication day for the Bank’s quarterly inflation report. Wonder what Ms Flint thinks about that…
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