Does anyone remember when the UK had 3 million unemployed?

This UK credit boom thing is playing out as if it was scripted. Back in 2001, the Bank of England sees a recession coming. So it cuts rates like a latin American central bank; a massive credit explosion follows, mostly centered on the housing market. Economic growth picks up, and the recession is temporarily avoided. However, the housing market spins out of control, people load up with debt, and consumer expenditure increases as if the world will end next week.

What do you get when you put it all together? Inflation. First it starts off slow, but then the Bank of England remembers just how persistent inflation can be. Once those prices start to rise, and people begin to expect 5 percent inflation every year, inflation gets nasty. Furthermore, growth starts to slide as inflation discourages savings and reduces investment. A recession can only be avoided by ever increasing monetary growth which in turn results in higher inflation. Sooner or later, the Bank has to decide - accelerating inflation or a nasty and extremely painful recession.

In the last 30 or so years, the Bank of England fought two serious battles against inflation - 1980-82 and 1989-91. On both occasions, the Bank of England jacked up rates, and the UK economy fell into terrible recessions that resulted in more than 3 million unemployed. That is the kind of policy response needed when inflation gets out of control.

I am not making any predictions that the UK is about to enter a catastrophic recession, that will leave millions unemployed. Rather, if the Bank of England doesn't get a grip on inflation now, then inflation will do what it always does, when it is left unchecked. It will accelerate. The longer the Bank dithers, the more painful will be the solution. The Bank is now raising rates; that is a good thing, but it isn't doing it quickly enough.

I am, however, making some strong predictions about the housing market. The housing market is about to collapse. Forget all those stories about a lack of supply. That lack of supply will still be there when house prices are 3 times income. People will still not be living in the homes that they want, and thirty somethings will still be living with their parents. This bubble won't survive in an environment of six percent interest rates.