Last week’s inflation number was absolutely stinking. You could have been fooled into thinking it was good news Because the headline rate fell from 10.1% to 8.7%, However, this decline was due only to the significant increase in energy prices last April, which were lower than the annual comparison.
The error in this piece was the core inflation rate – which, far from declining as some had hoped, actually rose from 6.2 percent to 6.8 percent. Nor can this be blamed on the current popular scapegoat, namely food prices. They are excluded from the primary scale.
No, this was hypertrophy pure and simple, tested pretty much across the board, everywhere. what is going on?
The Bank of England previously argued that The forces that drove prices up sharply were “temporary”. The same word was used by the US Federal Reserve. Both central banks were correct in this assessment of impulsiveness, but completely wrong in the conclusions they reached.
Central banks should never have forgotten that temporary increases in costs and prices can have persistent aftereffects because wages and prices chase each other up. The huge increases in oil prices in 1973/4 and 1979/80, which were followed by rampant inflation, could have been considered fleeting.
the bank has She finally accepted that she had made some mistakes during this period, In particular, something was wrong with the inflation forecasting model.
One problem that I and others have highlighted is the Bank’s apparent complete lack of interest in the money supply. Another is an overemphasis on inflation expectations. This was compounded by the assumption that since the central bank was dedicated to keeping the inflation rate at 2%, 2% would be the rate of inflation that was generally expected.
In practice, under normal circumstances, I would never have thought that expectations have such an overwhelming effect on people’s behavior. In general, both individuals and companies are more interested in what happened in the recent past and what appears to be happening in the present than in speculations about the future.
We live in a wage-price spiral The main impact was the pressure on living standards imposed by the huge increase in costs.
And this happened at a time when the labor market was very tight, due to the various factors that led to a decline in the available labor force, in the context of loose fiscal policy and highly accommodative monetary policy.
This failure of prediction led to policy failure. Not only did the Bank fail to raise interest rates early enough, it also didn’t raise them fast enough. The boldest move ever contemplated was to increase rates by 0.5%, instead of the usual 0.25%.
However, in the past, when the authorities wanted to control inflation, they were more aggressive. In June 1979, the bank interest rate was raised from 12% to 14% at once. Moreover, within a few months, interest rates increased by another 3% – from 14% to 17%. In September 1981, the authorities increased the rates in two pieces, from 12 percent to 16 percent. And many readers will remember the fateful day, September 16, 1992, when interest rates were raised twice, from 10% to 15%.
There is no doubt that bold monetary policy moves carry risks, even in the best of times. And we certainly do not live in the best of times.
Ideally, the bank would like to beat inflation without hurting economic growth or employment, and without risking a financial crisis—this last concern made more serious by The collapse of the pension fund last year In the wake of Truss/Kwarteng’s micro-budget.
But this is the motherhood and apple pie school of economic policy. In practice, once a cat is out of the bag, it is very difficult to put it back. This may lead to severe pain.
It is important for the monetary authorities to strike early and boldly against inflation. The problem is that if the central bank moves in gently, inflation may continue to run away from it. In fact, when inflation really gets to the head, the real interest rate can drop even as the central bank tightens.
What can we look forward to now? There is scope for the headline inflation rate to decline over the coming months as the monthly increases in the price level in the past year come out of the year-to-date comparison. Moreover, the rate of increase in producer prices—that is, the inputs into the production process and the price of goods leaving the factories—began to moderate.
However, the inflation process has already moved to the second and third stages. The source of the problem is no longer the price of commodities in the first place but the increase in unit labor costs. This is of particular importance in the service sector where labor costs are the dominant input.
If productivity growth remains minimal, to be consistent with inflation at 2%, earnings growth should average no more than 3%, compared to about 6% now.
For a while, I thought interest rates should go up to around 5%. This was a rather aggressive point of view. But no longer. Financial markets are now ruling out a rise to 5.5%. I think now the prices should go up to 6 pcs, or maybe even 7 pcs, to get this tiger back in his cage.
If I’m right, not only will this deal a severe blow to mortgage-takers, both current and potential, it will certainly lead to lower economic activity.
The International Monetary Fund may have recently become more optimistic about the UK economy and no longer expect a recession later this year. But if anything like these interest rates were to happen, deflation would be hard to avoid.
Roger Bootle is an independent senior advisor to Capital Economics: roger.bootle@capitaleconomics.com
