“Expect jitters if the consumer price index (CPI) today is any higher than 3.2%,” said Patrick Hosking in The Times on Tuesday. The CPI duly came in at 3.3%. The retail price index (the one we used to consider to be the correct measure of inflation) came in at 4.7%. So jitters it is.
The Bank of England has long insisted that under current conditions it’s impossible for inflation to become a real problem. What with the low levels of lending and apparently high levels of spare capacity, they say, falling prices are more of a risk than rising prices. It doesn’t seem to be working out that way. These numbers don’t just suggest that high inflation is a risk. They show it is already with us.
You can blame it on tax effects – “we don’t have inflation, we have tax”, says Fidelity’s Trevor Greetham. You can blame it on rising Chinese wages, which drive up the price of imported goods, or on the US quantitative easing (QE) binge – which has driven commodity prices higher across the globe. Note that copper keeps hitting new highs, that the oil price is back above $91 a barrel, and that everything from sugar to coffee is surging. But what you can’t do at this point, if you are a policy maker, is pretend it isn’t happening.
Why? Because the rest of us can’t do that. If it’s not possible for you to make a bean on your cash savings after tax and inflation are taken into account, you probably think there’s an inflation problem. If your wages regularly rise less than inflation, so that your standard of living falls a little each day, you probably think we have an inflation problem too. And if these two things keep going, which, given rising commodity and import prices and the coming rise in VAT they almost certainly will, you’ll definitely think we have an inflation problem. This means the Bank has to be seen to be taking CPI seriously. The more people expect inflation, the more likely they are to demand rising wages. That’s the kind of thing that kicks off nasty inflationary cycles.
However, while the obvious solution is for the Bank to raise interest rates, it isn’t a given that it will. Why? Because a rise in rates might slam the thousands of households whose finances are a wreck, but to whom low rates are a lifeline. It might hit house prices, which are almost entirely supported by ultra-low rates. This might hit consumer confidence. It would certainly hurt the banks. And it may well give us another recession.
The Bank clearly doesn’t want any of those things to happen. So it is staking its credibility on a bet that the risk of inflation taking off if rates are kept at 0.5% is much lower than the risk of a nasty double dip appearing if they are raised above 0.5%. I can see the dilemma, but given how high inflation is already, I’m not sure it’s a bet that will pay off in 2011.