Twin peaks: inflation 2008 and 2011

  • 18 October 2011
  • From the section Business
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Bank of England building
Should the Bank of England be doing more to tackle high inflation?

People keep saying it feels like the dark days of the financial crisis three years ago.

Well, in one respect, it is exactly like those times. Inflation now stands at 5.2%.

There has only been one other month when the CPI rate reached that level: September 2008. In fact, CPI was only introduced in 1997.

You have to go back to 1991 to find the broader RPI measure at a higher level than the 5.6% we have seen reported on Tuesday.

When that 2008 figure came out, the betting in the City was that inflation would fall rapidly - the average forecast was for inflation of 2.1% in 2009.

In the end, inflation was even lower than that. By September 2009 it had fallen to just 1.1%.

Today, the city economists are again betting that inflation will fall sharply. Both they and the Bank of England expect September to be the peak.

The average prediction for inflation in 2012 is now 2.5%, less than half of the latest figure.

Painful news

Unfortunately, they expect inflation to fall for the same reason it fell after 2008 - because of weakening demand in the UK and broader global economy. (The other bit of news we had on Tuesday was that even the mighty Chinese economy has been slowing down).

As many have pointed out, this is a good month for inflation to peak if you are reliant on state benefits. And it's a very bad month for it to happen if you're the chancellor, once again forced to uprate benefits in line with a record high inflation rate.

But if you're mainly dependent on savings income this is painful news. The figures show the cost of fuel and light, for example, have risen by nearly 19% in the past year.

Do these numbers alter the case for more quantitative easing? The governor of the Bank of England would say no; policy must be set with a view to the future, which monetary policy can hope to affect, not past prices which have already occurred.

But, as we heard on the Today programme on Tuesday morning (0750), there are plenty of critics who would see the 5.2% inflation rate as further damning evidence that the Bank of England has run away from its job.

In my recent interview with Governor Mervyn King, he insisted that "allowing" this inflation to occur had been the lesser of two evils: had the bank sought to avoid it, the economy would have slipped back into recession and everyone - including pensioners and savers - would have been worse off.

In the Bank's view of the world, the single greatest threat for a highly indebted economy, coming out of a major financial crisis, is deflation - falling prices - which can push you into a downward spiral, like Japan.

Measured by that standard, the Bank's Monetary Policy Committee has been remarkably successful.

In cash terms, our national income, or GDP, rose by 8.4% between the second quarter of 2009 and the same period this year. That's the same as America, and a lot more than the eurozone economies, who grew by 5.9% in nominal terms over the same two years.

The cash value of the Japanese economy has actually shrunk in that period, by 2.3%.

But when you strip out inflation, only Japan has grown more slowly than the UK since 2009: we have seen just 2.8% growth in real GDP since the second quarter of 2009, compared to 5% for the US and 3.8% for the eurozone.

Overall growth in GDP has not been the problem - it's the composition that has been lousy.

Squeezed incomes

The Bank would say that's not its problem. It's the crisis - and rising commodity prices and VAT - that has caused the squeeze in real incomes and growth. Pushing down inflation artificially would only have made that squeeze more painful.

But some, like Richard Jeffrey at Cazenove, think the causation runs at least partly the other way; growth has been slow, because incomes are being squeezed and households have less and less to spend.

Spending by households was actually 9% higher, in cash terms, in the second quarter of 2011 than at the low point of the recession. But in real terms, spending has barely risen at all - the level of spending is just 0.1% higher than in 2009.

The argument over the Bank of England's strategy will not end here - but the relentless rise in inflation should. If the gloomy trends continue the prospects for inflation could look starkly different in a year's time.

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