Tuesday, 13 May 2008

UK inflation has the big "mo"

Members of the monetary policy committee must have groaned when they saw today's CPI numbers. The rate touched 3 percent. Moreover, April saw the highest monthly increase in six years. If it was a fraction higher, Mervyn King would have been forced to write a humiliating letter explaining why the Bank of England had failed to maintain price stability.

With inflation deteriorating rapidly there will be no more talk of interest rate cuts for quite some time. In fact, there is now a compelling case for a shift towards a policy tightening. During the last 34 months, the Bank of England have met their inflation target just 6 times. When they did manage to get inflation below two percent, it was invariably by just 0.1 percent.

The Bank is now building up a solid track record of weak counter-inflationary credibility. If they keep it going much longer, price expectations will begin to rise. If that happens, then brace yourself for an inflation rate close to 6 or 7 percent.

The last six months have been just horrible in terms of inflation dynamics. The rate now has some serious momentum behind it. As the chart above clearly illustrates, the rate accelerating rapidly. There is only one thing that is going stop it from racing out of control - higher interest rates.

But why am I talking about the CPI? As I have mentioned in earlier posts, it persistently understates the true level of inflation by excluding housing costs. The RPI is a better measure. Here, the story is little better. The RPI has remained solidly above 4 percent for well over a year.

However, where is the upward inflationary momentum that is so obvious in the CPI? Here is a laugh. Falling housing costs took some of the edge off the RPI inflation rate. Now there is an irony for you.

5 comments:

Sick of housing market said...

Blanchflower must be really upset. He was desperate to cut rates.

Vado said...

Don't worry, Mervyn will be writing his letter next month. How long before 4% inflation. September, perhaps?

aSteve said...

I agree - next month we'll get the letter.

The reason that I don't think we'll see rate rises can be summarised in this completely unjustified projection of where I see two different strategies playing out.

http://tinyurl.com/4sr634

Anonymous said...

Writing a letter doesn't mean a thing. Everyone is firefighting right now. I think the BoE has to hike rates soon but will try to put it off as long as possible. As you note with the CPI, tomorrow is fast arriving.

I think there'll be plenty more begging in the media for rate cuts. It's like watching teenagers arguing with parents over not doing their homework.

Of course if a newspaper actually came out in favour of higher rates, that would be interesting. For example, in the week leading up to an MPC meeting the page 2 of City AM is constantly full of begging for rate cuts disguised as news reporting.

Nick

aSteve said...

Writing a letter does mean something to me. It means I get to read a carefully thought out document.

It is also something that the media will pick up on, and will have an influence on sentiment.