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.