Tuesday, 18 March 2008

UK inflation, back on an upswing


(click on the chart for a sharper image)

The first victim of the credit crunch was, of course, Northern Rock. However, the second victim was undoubtedly the Bank of England's commitment to reducing inflation.

Keeping prices under control doesn't seem to matter that much these days. The Bank of England has just completed a cycle of higher interest rates. Yet despite a series of hikes, inflation hasn't responded. Choose your indicator - the RPI or the CPI - both are showing increasing inflationary pressures.

Today, the CPI reached 2.5 percent. However, it is on a strong upward trajectory. Within two or three months, it should be well passed the 3 percent threshold requiring a further letter from Mr. King to Mr. Darling. Furthermore, it has been more or less consistently above the two percent target since mid-2005.

The more accurate and representative RPI offers an even more bleak assessment of inflationary trends. After accelerating in 2006, it has remained stubbornly above 4 percent for more than a year.

Unfortunately, the credit crunch provides an excuse behind which the Bank of England can now hide. The MPC will not be raising interest rates to respond to the growing inflationary threat. Instead, the MPC will target the welfare of the banking system. A renewed cycle of higher rates would only lead to higher mortgage default rates, and that would put balance sheets under further distress. We can't have any of that in an economy dominated by the financial system.

However, the credit crunch is a mask behind which we find the housing market. Today, the imperative is to keep house prices high; this obsession drives economic policy in the UK. Economic growth, inflation, balance of payments stability, fiscal balance - each one of these key measures of economic welfare play second fiddle to the bubble.

In the early part of this decade, low rates feed the bubble. When inflation got a little frisky in 2005, the MPC raised rates, but quickly retreated when the housing market started to slow. Inflation picked up again in 2006 and the MPC tightened. However, by 2007 the banking sector was overloaded with bubble debt. Faced with a housing-related financial sector meltdown, the MPC retreated. Faced with the choice, lower inflation or lower house prices, the MPC chose the interests of the housing market.

Wouldn't have been so much better if the housing bubble had been popped back in 2005? The banking sector would be in better shape, inflation would have been lower, and our current account deficit would have been reduced. This would have put us in better shape for dealing with the inevitable slowdown created by the idiocy across the Atlantic.

5 comments:

Anonymous said...

Just like Alistar darling, I have some sympathy for Mr King and those on the MPC. With personal debt in the UK at around £1,400 billion they have been left with precious little room for potential interest rate hikes when it comes to inflationary pressures. Like 1929/70's/89 our current economic woes are stacking up to be looked upon with similar notoriety. If we get away with a 'simple' recession I think many will be relieved.

Chefdave

Anonymous said...

Inflation at only 4% - you havin' a laff. It is more like 10%

Josh

traderboy said...

Josh, as I mentioned in detail on a previous post recently when you said this...what is running at 10% inflation? petrol, yes, bread, maybe, anything else? despite all the talk, i don't think it is anywhere even close to this level.

i was also wondering how easy it is for whoever does it to measure prices of things consistently...every time i go to the supermarket, the price swings seem wild depending on what's on special. eg. a 2L bottle of coke will be £1.50 one day and £0.72 the next (if you buy 2!).

andyrich29 said...

Trader Boy are you living on this planet? just a few other things running at between 5-15% inflation.

1) Council Tax
2) Electricity
3) Gas
4) Water Bills
5) Many Other food items

High house prices have helped cause this mess. People want more money to pay for them.

traderboy said...

andyrich29, i am living in london and don't have my head in the clouds!

council tax in london, doing a quick google search, looks to be around 3.50% (most councils claim s it really up 2.5% but the Greater London Authority tack on about 1% more). I also notice that in scotland they are not raising council tax at all in general (that's 0%!)

utilities, yeah that doesn't surprise me.

water...from this Feb '08 article "Water companies have been given the go-ahead by Ofwat to increase prices by an average of 5.8%." A lot, but still not 10%.

And as for food, i'm not sure. my local morrissons seems pretty cheap especially with the specials...i find tesco and sainsbury's harder to tell cos all they ever have is buy 1 get 1, buy 4 get 1 free, or all other sorts of crazy deals on stuff that you'd never actually want to buy more than 1 of!

on the odd occassion when i go clothes shopping, stuff seems to be coming down in price, as do CD's/DVD's, any electronics goods, etc etc.

my gym membership this year went up £1, that was less than 1%.

not denying inflation (although personally i believe in deflation and that the commodity crash is coming, which will take prices down), just denying that it's 10% across the board.

cheers.