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It’s started already.
The Bank of England should abandon its inflation target, claims Peter Spencer of the Ernst & Young Item Club. “The consumer will have to be crucified in order to meet the inflation target as it stands at the moment,” he says.
Professor Spencer reckons the Bank needs to switch to core inflation instead. That’s inflation excluding food, energy and other so-called volatile items. This measure should be targeted at 1.5%.
Conveniently enough, by that measure inflation is currently at 1.4%. That would leave the Bank some leeway to cut interest rates – exactly what Gordon Brown hopes it will do…
Why the arguments for core inflation don’t stack up
There are a couple of seemingly compelling points behind Peter Spencer’s argument that the Bank of England should focus on core inflation.
The argument goes that the Bank can’t directly control the price of oil, or the price of food, or your gas bill for that matter. Because you have to pay for all these things anyway, in some ways they act as a tax. Money spent on them means less to spend on other things.
If people can’t afford to spend on other consumer items, then retailers won’t be able to pass on the costs. More companies will go to the wall, more people will lose their jobs, people will continue to cut spending, and so on in a vicious cycle. So inflation can’t feed onto the high street, so there’s no point on worrying about oil etc when you’re calculating inflation.
Interesting points. But flawed for a number of reasons. For one thing, the reason to include pipeline pressures, like soaring raw material prices, in your inflation measure, is to make sure you’re ahead of the curve. As many people have said, inflation’s like toothpaste – it comes out of the tube a lot easier than it goes back in. So the central bank has to set rates in anticipation of higher inflation.
This issue about retailers having to absorb higher prices is interesting too. It seems to make sense in theory, but I’m not sure it’s true in practice. MoneyWeek columnist, Simon Nixon of Breakingviews.com, says in this week’s issue that all the company bosses he’s been speaking to are planning to raise prices, and indeed, many retailers have been trying to soften us all up for price rises in recent months.
We’ve heard about the end of cheap clothing, the end of cheap food, even the end of cheap electronics is being mooted in some corners. Interest rate cuts would only make this worse, by hurting sterling and driving the cost of imports higher.
How could shops put up prices and survive in a recessionary environment? Here’s how. When demand was high, and lots of people were out shopping, an equally large number of shops set up to compete for their business. High competition keeps prices down.
But as demand falls and times get tougher, a lot of the weaker chains will go to the wall. The absolute level of demand might fall, but so will the number of companies competing to service that demand. The less competition there is, the more pricing power the survivors have. So a recession is no guarantee of lower inflation.
This is all beside the point, partly anyway. The real problem is that too many people are still clinging to the fantasy land of cheap credit and low inflation. It’s been so long since inflation was a problem that people have forgotten that it’s bad for them. What’s so bad about rising prices, they wonder.
Well, instability for one thing. As Edward Hadas points out on Breakingviews.com, it’s impossible for businesses to plan ahead when they don’t know how much their money and investments are going to be worth in real terms from one week to the next. That means they demand very high returns to compensate. So if you think the credit crunch is bad, wait ‘til you see the kind of risk aversion that rampant inflation engenders.
And of course, inflation punishes anyone who sat out the whole debt bubble mania. People on fixed incomes, people who’ve been saving – inflation ruins them and makes saving seem pointless, which again damages future investment.
So inflation’s bad. But another point against Professor Spencer’s idea is the moral hazard argument. We already changed the inflation target once, back in 2003, from RPIX (Retail Price Inflation excluding mortgage payments) to CPI (Consumer Price Inflation). Now this had a lot to do with Gordon Brown indulging Tony Blair’s hopes that Britain might join the euro one day (CPI is basically the same measure as Europe uses for inflation). But it had the convenient side effect of making monetary policy easier. It’s rarely pointed out, but if we were still using RPIX (under which the top end of the inflation target was 3.5%) then governor Mervyn King would have had to write several letters by now – last month RPIX came in at 4%.
If we switch targets yet again, to make monetary policy even easier, just because we don’t like what the figures are telling us, that will destroy what little faith in the statistics that people still have. Inflation expectations will rocket in the absence of a reliable measure, and you’ll make the whole situation far worse.
A much smarter idea – which is also being touted around on both sides of the Atlantic just now – is that central banks should be allowed to target asset price inflation after all. In other words, if one part of the economy is clearly in a bubble and interfering with the sane functioning of the rest, then the banks should be able to take steps to prevent that getting out of hand.
But bubbles are so much fun when they’re inflating that no one wants to pop them early. So this is one good idea that I suspect will be ignored. For now, pressure groups and the Government just want things to go back to the way they were. That’s impossible, but it doesn’t mean they won’t try.
If you really want to rob the poor, Mr Brown, forget about scrapping 10p tax bands. Dump your inflation target, and watch as the pensioners, the low paid, and those who saved their money in the mistaken belief they were being responsible citizens, slide into penury as their fixed incomes utterly fail to keep up with living costs.
But then, all those buy-to-let investors will vote for you, so who knows – it might be worth it.
Turning to the wider markets…
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The FTSE 100 closed up 35 points 6,251. Telecoms giant BT was the main riser after a solid set of full-year results.
The FTSE 100 closed up 35 points 6,251. Telecoms giant BT was the main riser after a solid set of full-year results.
Across the Channel yesterday, the Paris CAC-40 was barely changed, rising 2 points to end the day at 5,057. And in Frankfurt, the DAX-30 fell 2 points to 7,081.
On Wall Street, US stocks moved higher as broadcaster CBS said it would buy technology news provider CNet Networks for $1.8bn. The Dow Jones gained 94 points to end at 12,992. The broader S&P 500 climbed 14 points to close at 1,423, while the tech-heavy Nasdaq rose 37 points to close at 2,533.
In Asia this morning, Japanese stocks slipped back as retailers fell, amid economic data suggesting falls in domestic consumer spending. The Nikkei 225 fell 32 points to 14,219. The falls came despite news that the economy grew faster than expected last quarter, at a 3.3% annual rate.
Crude oil was trading at $124.30 in New York. Meanwhile Brent spot was trading at $121.92. Spot gold was trading at around $884 an ounce this morning, while silver was trading at $16.82. Platinum traded around $2,088.
Turning to forex, sterling was trading at 1.9485 against the dollar, and at 1.2576 against the euro. The dollar was last trading at 0.6454 against the euro and 104.25 against the Japanese yen.
This morning, British Airways said full-year profit had more than doubled to £680m. Business travel on cross-Atlantic routes was the main driver. The airline also paid its first dividend in seven years. However, the group said the next 12 months will be “challenging” amid soaring fuel prices.
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On Wall Street, US stocks moved higher as broadcaster CBS said it would buy technology news provider CNet Networks for $1.8bn. The Dow Jones gained 94 points to end at 12,992. The broader S&P 500 climbed 14 points to close at 1,423, while the tech-heavy Nasdaq rose 37 points to close at 2,533.
In Asia this morning, Japanese stocks slipped back as retailers fell, amid economic data suggesting falls in domestic consumer spending. The Nikkei 225 fell 32 points to 14,219. The falls came despite news that the economy grew faster than expected last quarter, at a 3.3% annual rate.
Crude oil was trading at $124.30 in New York. Meanwhile Brent spot was trading at $121.92. Spot gold was trading at around $884 an ounce this morning, while silver was trading at $16.82. Platinum traded around $2,088.
Turning to forex, sterling was trading at 1.9485 against the dollar, and at 1.2576 against the euro. The dollar was last trading at 0.6454 against the euro and 104.25 against the Japanese yen.
This morning, British Airways said full-year profit had more than doubled to £680m. Business travel on cross-Atlantic routes was the main driver. The airline also paid its first dividend in seven years. However, the group said the next 12 months will be “challenging” amid soaring fuel prices.
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Tap into the Canadian economic boom
– What’s the attraction of a remote city in the Canadian Midwest, where temperatures regularly top out at less than -17 C? Simple, says Nick Lanyi. Cash. And here’s how you can make some too – click here: Tap into the Canadian economic boom
Shares rally could prove short-lived
– Central bank bailouts have recently revived ailing stockmarkets as investors have regained their risk appetites. But history shows that bear market rallies are generally followed by further steep falls. To read more on why the foundations for the equity market’s rally may be built on sand, click here: Shares rally could prove short-lived