Time for interest rates to rise?
The fall in living standards is now moving centre stage in our politics and economics. I suspect it’s about to over take "the cuts" in political and economic significance.
Real disposable income fell almost 1% in 2010 -- the first "national pay cut" in over decades. Rising inflation and taxes (Vat up, NI about to go up) coupled with slow growth in wages (just over 2% annually when inflation is over 5%) mean it is almost certain to fall again in 2011.
The decline in living standards is already affecting consumer spending, which in turn is undermining retail sales, which are weak. Indeed the retail boom is well and truly over.
The country's high streets and supermarkets are already awash with discounts and two-for-one special offers. Around 40% of supermarket shelves now boast "special offers", an all-time record. Dixons has just issued a profits warning.
A new survey out today will show that consumer confidence has collapsed back to where it was at the height of the financial meltdown.
Rampant inflation has serious consequences for economic policy. When prices (and taxes) are rising much faster than wages -- as they are now -- then people feel the squeeze. They are forced to tighten their belts. They reduce their spending.
But consumer spending accounts for almost 70% of GDP. So when it slows, so does the economy. Hence the downgrading of growth forecasts in last week's Budget.
The normal response to rising inflation is a rise in interest rates. Many voices -- including that of the Bank of England Governor -- have resisted, on the grounds that it would slow the recovery. That is indeed a risk.
But rising inflation -- because of its squeeze on living standards -- is also slowing the recovery (as well as increasing government borrowing). So doing nothing is not with its risks to growth too -- and inaction now could mean much steeper rises in interest rates later.
It all depends on whether you think the current rise in inflation is a temporary blip -- or something that will be with us for a while. If the former, you might want to delay raising rates (though some rise is coming later this year whatever happens).
If the latter, then the sooner you start raising rates the better.