We clearly have an 'inflation problem'
I suspect it won't be long before interest rates come down the pike.
The Treasury is getting used to these little billet doux from the Governor -- last year Mr King had to write three of them. The Bank will no doubt stick to its line that it's really all a blip and that inflation will soon fall back. But even core inflation (stripping out short-term factors) is at 3% (50% higher than the Bank's target).
Mr King has had to concede that the CPI will stay at between 4 and 5% for the rest of the year ie it will get worse in 2011 before it gets better. The Retail Price Index (RPI), which includes housing costs and is seen as a better guide to rising prices for the average consumer, already hit 5.1% in January.
The usual suspects -- rising oil, commodity and food prices, the increase in Vat -- are being blamed. But (bar the Vat rise) all major economies are being battered by these trends. Yet compared with the US or the Eurozone, UK inflation is distinctly higher. Unlike our major competitors we clearly have an "inflation problem".
It will become more of a problem if these price rises are reflected in wage settlements, in which case inflation will become entrenched and the Governor's blip theory will be in shreds. There's a tight pay policy in the public sector -- but that will test the government's will if it leads to widespread strikes. Private sector pay rises are still muted. But big companies are flush with cash and might decide to meet pay demands rather than endure industrial disruption.
Mr King's reputation and credibility is on the line here, not just in Britain but abroad too. The New York Times Business Section recently published a less than complimentary analysis of his record. Meanwhile, back in Blighty, living standards are about to be squeezed even tighter, which means consumer spending is hardly likely to lead the recovery.
Oh yes, and the markets are pricing in a quarter-point rate rise by May, and at least one more by the end of the year.
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This will surely test the independence of the BoE. The Coalition will be loath to implement interest rate increases while growth remains nil (or negative).
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I'm no economist but I am sure that QE has something to do with this - nothing is for nothing.
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There is not an inflation problem so long as three key conditions hold:
1) As you allude to, price rises do not feed back into wage increases.
2) Expectations of inflation do not increase significantly.
3) The price rises in volatile products (food, oil) do not feed back into the prices of products whose prices are adjusted infrequently.
The wage-price spiral in 1) is highly feared and any evidence of this emerging would cause an immediate shift in central bank policy. At the moment it doesn't appear to be happening, so the bank is preferring to keep rates low.
Increasing expectations of inflation are not all bad. If interest rates stay constant (that is, all interest rates, not just the Bank central rate) and expectations of inflation increase, the real interest rate drops, becoming even negative, and giving the economy an extra shot in the arm.
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It is a fine old mess.
Anyone who has experience of rising inflation knows the damage it does to Economies and personal health, wealth and happiness but we have such a sluggish economy that anything we do now may have really serious adverse impacts far worse than a rate of inflation 'that might rise to 4.5% before stabilising'.
Raising Interest Rates will lead the Banks and other lending institutions raising their rates which will cost the existing citizen borrowers more ...
In the past borrowers would have simply rescheduled their debts or borrowed other loans to lessen the impact of increased personal borrowing costs but with the current stalemate in Bank Lending, reduction in borrowing opportunities and the fact that the level of personal debt in the UK is so humungous.
The fact of the matter is that at a personal level many UK citizens are too hevily indebted to their Crdit Cards, Bank Loans and with mortgages that, if taken out during the period of 'light touch' regulations espoused by Brown and the Labour Government they are now likely to be owing more than the value of their homes with much reduced chance of resale to eliminate the debt.
To raise interest rates too prematurely would really be potentially more damaging to the citizens of the UK than trying to inflate the UK Economy when it is still chugging along at a pitiful rate of growth - if not in dire risk of a double-dip recession.
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"which means consumer spending is hardly likely to lead the recovery."
So this underlines the problem of a private sector lead recovery. So where does the government go from here.
Their biggest fault is not just about their simplistic approach but also in boxing themselves in politicaly.
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Lay much of the blame at the door of Quantitative Easing - Gordon Brown's Poisoned Chalice.
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Good Morning Andrew,
thanks for covering this important subject again. I have said before that interest rates must rise, and that the policy of Quantitaive Easing must cease. Germany found out to its cost that inflation, and printing money, solves nothing.
It is time for King to get a grip, or resign, and hand over to somebody not tainted by his appalling mismanagement. We have Merv the Swerve, whilst we need a Steady Eddie.
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When we talk about inflation possibly coming down next year then think what this means.
A good is sold for £100, then later it is sold for £105, so inflation is 5%. Now next year inflation is 4% so the good is then sold for £109.20. However, the price is still a lot higher than it was at the start of the process. So, inflation might be down in a years time, but what will really be needed is deflation so that at the end of year two the price of the good is less than £105, not more than.
In fact it should really be less than £100, the country must expect a period of deflation, asset prices must be allowed to fall, just as they did in the early part of the 1920s, before people chickened out and attempted to preserve asset values. The whole of the western economoies have really been in a depression since the Great Crash of 1987, and all the problems can be traced back to October 1987, that is when the financial system was first baled out, and it's been going on to varying degrees ever since. Too big to fail is not a new phenomina.
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Industrial costs are spiralling due to factors beyond our control, base metal prices have risen and special alloys no longer manufactured in the UK have risen disproportionally. Component costs and lead times are similarly affected, with the resurgence of the German economy suppliers are in no mood to negotiate when they have markets elsewhere.
All this adds up to increased factory prices, regardless of what the interest rate is. The perceived wisdom is that raising interest rates combats inflation but in this environment will increasing interest rates really address the problems?
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Thank you Andrew for a reasonable and balanced view of the problems facing us on the inflation front. None of the solutions are easy but as I have been writing for some time we are indeed facing difficult choices. Unfortunately the Bank of England keeps taking the easy way out.
The Monetary Policy Committee has made a lot of errors with its inflation forecasting.In essence it always predicts it will fall due to its "output gap" theories and so far in the post credit crunch era it is always wrong! This is important and to illustrate this let me quote from my notayesmanseconomics blog from today.
"Let us go back to the quarterly inflation report from February 2010 and examine what it forecast for now........If we look at the accompanying fan chart we can see that the Bank of England expected CPI inflation to be approximately 1% at this time before drifting up to 2% in 2013."
Its policy of 0.5% interest-rates and £200 billion of asset purchases was based on this forecastwhich has turned out (again) to be very wide of the mark. Accordingly as the Bank of England bases its policy on this then by its own definition policy has been wrong...
So not only should it be answering why it is not responding to an obvious problem it needs to explain why it keeps getting things wrong.Frankly politicians could do the job this badly!
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The problem is as follows.
1. The 2% target is ambitiously low. What we are actually experiencing at the moment, 4% inflation (or even 5.1%) isn't too bad. The time to start worrying is when it rises above 5% and its clearly a problem when 10% or more.
2. The ONS figures don't seem to accurately reflect the level of inflation that many people are experiencing in the real world. Dunno why, but I reckon my expenditure has increased by considerably more than the official figures suggest, despite my cutting corners wherever I can...
So yes we do have a problem, but its more fundamental than is suggested in your blog posting Andrew. Its more than just inconvenient numbers...
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Interest rates to start creeping up, I think. DeAnne Julius - who got it right on the MPC when arguing for rate CUTS before anyone else, and always comes over (IMO) as one of very few people who really knows what she's about - is saying it's time to start increasing now. That's good enough for me.
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This has been on the horizon ever since QE was mooted as a way of inflating away the debt. Thanks Gordon....
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Good Morning Andrew,
it would appear that some are reverting to the policy of saying I told you so is not an economic policy. Well it is about time that the Chancellor actually called the Governor in and asked for his resignation because his whole policy of low interest rates has not worked. I am not saying this with the benefit of hindsight, and in the past some on your blog have said that interest rates needed to rise some time ago.
The trouble is that if rates had been raised earlier then they would not have to rise as high as they will. I think that if the Chancellor does call in the governor then all that the Chancellor would be able to say if the governor asks, well what do you want me to, tell me, and I'll do it, and all that Osborn will be able to say is you're an independent sort of guy, so search me guv. Somebody is going to have to get a grip on all this, we are so doomed.
Interest rates should be raised immediately to 2%, Quantitative Easing must cease, and there must be control over lending, lending just feeds the inflation, whether it be home grown, or imported. We are going to see a dramatic fall in living standards as some people take on the effect of the demographic time bomb with the massive reduction in income for the 'baby boomers' born between 1944-1949. I blame the Tonnage Act.
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Rates could go up this year says Merv the Swerve, only we won't tell you. So, if interest rates are to rise, as they should, then who would lend money long term, and by that I mean more than three months, if the return on your lending would be better if you held back. So, surely, any decent financial adviser would say don't fix your money at the moment, if you are going to lend, then hang back. However, if you are to borrow than borrow now, before rates rise, but who can get a fixed loan.
There is also all this talk of council executives being paid more than the PM. Well consider all those teachers on, or close, to 'earning' £100,000. Consider all those individuals who 'work' in the charitable sector who 'earn' over £50,000. Consider all those directors on more than one board who are paid tens of thousands for doing one, two, or three days 'work'. Finally, consider the guvnor of the Bank of England, and what does he actually 'do' for his money. In fact, what do all these directors of services for councils actually do for their money, they don't seem to be able to manage anything, and who exactly elects these people, I elect councillors, not Chief executives, or directors of this that or the other.
Andrew, it is no surprise that there is rampant inflation, nobody seems to actually do anything, it is time that somebody got a grip, it is not only bankers who are like a virus, it seems there are a lot of people who get up other peoples noses.
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Andrew,
I have always regarded the economy as a bit of a supertanker, once it is going in one direction, it is difficult to change course. Once the orders are given to change course it takes miles before the direction is changed.
My problem is that as it is 100 years since the sinking of the Titanic we ought to be careful that the economy does not change course to port or starboard but that it sinks to the bottom of the ocean with the government of national unity playing their instruments whilst the waves splash over the poop deck.
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The Governor rationalised QE and interest rates at historic lows because he feared deflation. I suspect what he really meant was the debt spiral that comes from not having enough income to pay your debts and your living expenses at the same time.
However, we have avoided that particular condition and so, in the words of the banking fraternity, we have to move on.
The argument now for continuing this policy is that we have a crocked economy trying to grow at the same time as wiping out a fiscal deficit of quite heroic proportions but which is also facing rising inflation. This is a contradiction which can only be the consequence of policy failure at some point somewhere.
The argument that this is due to a drop in sterling against the US dollar over two years ago is a bit thin. Sterling has been gaining against the US dollar recently, perhaps in expectation of a rise in interest rates.
I am increasingly coming to the conclusion that there is more than one economy in the UK. There is the real economy that is staggering along punch-drunk but which has cut back, there is the government economy which is cutting back and the banking economy which is locked in permanent show-time. There is also the `black' economy which still seems quite prosperous but which does not appear in the numbers so should be discountable.
I think the Governor should swallow hard and forget about that deflation. It did not happen. We now have inflation so an interest rate rise is necessary. There are much serious risks if we don't try to get back to everyone being in the real economy with real money producing real value.
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#17
when are some of us guys going to be asked to do some charity work for the government of national unity to help dig them out of a hole. I don't mind taking the blame for all the difficult decisions, because sometimes these people just can't see the wood for the trees.
Talking of trees, I asked a question of my local county council about Haldon Forest, down here in Devon. They let the cat out of the bag when they stated on the 9th February 'The parts of Haldon Forest that are currently in the County Council's ownership will remain in our ownership and are outside the scope of any proposals for disposal of forestry that is currently owned by central government'. I think that the government is coming up against the age old problem of trying to dispose of assets which are not actually in their ownership.
Talking more on forests was it not Prince Charles who made substantial sums of money by selling some of the woodland which he owned. Why are there still tax breaks for woodland when the whole idea behind giving tax breaks was that we needed to preserve growing trees either for the ships of the line, or the pit props for the mines, or the trenches.
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#17 stanilic - actually, you'd be surprised how laggy is the relationship between inflation and exchange rate changes. In mid 2009 I was talking to people in the distribution and manufacturing sectors who were predicting based on their experience that the inflation response to Brown's run on the pound would be "surprisingly" muted until mid-late 2010 - but would then be very noticeable in late 2010-early 2011. They reckoned it took 18-24 months for exchange rates to really affect the prices they charged - in the first instance they'd run down inventory bought at the old exchange rate, which would give them time to try to find alternative suppliers, and then design in cheaper components - only then, after 18 months or so, would they finally resort to pushing up prices.
So I guess on that basis, there is room for a bit of cautious optimism on the inflation front, unfashionable though it might be, we're more or less working that big lurch down to $1.40 in late 2008 out of the system, and the dip to $1.45 a year ago probably wasn't sustained enough to be much of an issue.
#2 Hewson Jack - you only get inflation from printing money if the velocity of money stays constant. The credit crunch represents the biggest brake on the velocity of money ever in a modern economy, so despite QE, _potentially_ we could escape without too much inflation if QE is tied to the velocity of money, and hence things like bank lending. But noone really knows exactly how the links will work, it's a giant experiment.
Andrew - whilst I'm here, just a quick comment on recent guests in the TW1 slot. Really enjoyed Rageh Omaar, Greg Dyke was good value - but who on earth let Fiona Phillips in to do the NHS? She would have been out of her depth in a paddling pool, it was almost as bad as Wozza on economics. It was particularly frustrating as there was a real opportunity for someone in the more usual left-field-but-knowledgeable line we expect for TW1 - perhaps a European doctor, there's enough kicking round our university hospitals, or even someone like Gunther von Hagens?
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The inflation pressures this time around do not specifically fall into any particular economic theory. The main area where demand exists is in staples i.e. the food we eat, water and fuel for heating and transport. Some people have pointed at cost which is true to an extent, but I suspect that profiteering and exploitation is also going on.
This is quite apparent in food retailing where the supermarket chains dominate but competition has been diluted over the last decade. There is a cosy "gentleman's agreement" between the supermarket chains whereby rival stores do not operate too closely to each other geographically - I used to work for loyalty card marketing company for one of the big supermarket chains.
Supermarket chains routinely raise and lower prioes mostly to generate promotional sales of say 50 percent off on champagne before Xmas when in the Autumn it had been raised by the same amount. Additionally utility prices have been hiked recently and cost is not an issue there. Gas has always been a bye-product of oil extraction and its price a formulaic dependent on the oil price - the cost of gas extraction has already been borne by the oil extraction. Two summers ago when oil peaked at USD 150/barrel the oil companies were "allowed" to break the formulaic, when the oil price then dipped.
The authorities need to investigate the broken energy market where quite frankly collusion and profiteering is taking place. Costs have not risen but nefarious speculative practices have, this area needs to be regulated otherwise any economic recovery in the UK will hit the buffers big time.
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19
Then you informants were carrying too much stock. The pit was in early 2009 which means that the 18-month lag would have been mid-summer last year. I would think the flight of investors into raw materials is more the problem than the rate of exchange.
At the moment sterling is performing better against the US dollar for over two years but are prices dropping? No fear!
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aggers @ 19
"left-field-but-knowledgeable"
What do you mean, Left 'but' knowledgeable? - 'and' knowledgeable, surely. Or at a push, 'therefore'.
You wouldn't go around saying 'she's pretty but clever' ... would you?
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Stanilic
Interest rates seem a blunt instrument at this juncture - when inflation is not consumer lead, apart from possibly increasing the exchange rate what will increasing interest rates achieve?
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Would be good for savers, Coats. They aren't getting much on their money at present, haven't been for ages. Although it's spending we want to encourage, not squirreling, to pull us out of this. But then again, longer term, the view seems to be that we should try to move to an economy less dependent on consumer frolics, so I don't know really. Guess nobody else does either, truth be told, they just pretend they do.
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