This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for Money Morning
We did say that the Bank of England should have raised interest rates this month – and we wonder if perhaps the Monetary Policy Committee is now wishing it had done just that.
News that consumer price inflation hit 3.1% in March meant that Mervyn King has had to write a letter to the Chancellor, explaining why inflation had breached the Bank’s target range, for the first time since the new measure and target were introduced. Meanwhile, retail price inflation hit 4.8%, its highest level since July 1991.
As regular readers know only too well – we’ve been saying it for quite some time now – inflation in this country and across the rest of the world is a lot more entrenched and much more of a risk than mainstream forecasters believe.
Not a single economic forecaster polled by Reuters before yesterday’s CPI data predicted that it would go as high as 3.1%.
And despite all the hullabaloo following the shock surge in March, we suspect that they’ll continue to underestimate inflation – until it’s far too late…
Bank of England governor Mervyn King’s letter to the Chancellor on inflation read like an attempt to soothe Gordon Brown – and the rest of us – into thinking that everything is going to be OK. He argued that inflation would come down later in the year (something we’ve been hearing for a while now), as the impact of sharp gas and electricity price hikes falls out of the comparison figures.
In turn, Mr Brown’s cordial reply sounded like an attempt to soothe the electorate into thinking that nothing could go wrong and they should still vote for him. The rise in inflation was largely dismissed as part of a global phenomenon based on rising oil prices – nothing to worry about there, and certainly not a UK-specific problem.
But Michael Saunders at Citigroup pointed out the flaw in King’s argument. “Yes, inflation will fall back sharply at first, but this is not benign. We’re seeing a gradual rise in non-energy inflation which will pick up later in the year. I think it is conceivable that the Monetary Policy Committee will raise rates a half point in May.”
Mr Saunders has hit the nail on the head – the key problem is that the rise in inflation was fuelled by much more than just higher petrol prices or gas bills. We are now seeing price gains in the kinds of things that have up until very recently not really featured in the monthly release from National Statistics. Items like furniture, toys, clothes – deflation in these items, mostly imports from China, has been one of the main factors in keeping inflation down. But that seems to be at an end now.
And of course, as inflation just keeps rising – particularly when it breaches a high-profile target like this – people start to mutter about how their wages can keep up.
There’s an interesting little exchange in a BBC feature entitled “High inflation and you”. The piece is laid out in a question and answer format, explaining very simplistically what the leap in inflation means. One question is whether wages will have to rise. The answer from the man at the Beeb is “Yes, and it should be by more than 3.1%. Wages and benefits are pegged not to the Consumer Prices Index but the Retail Prices Index, which includes housing costs and currently grows by 4.8%.”
News that wages are pegged to anything will be a revelation to most employers – particularly Gordon Brown, who, in his reply to Mervyn King’s inflation letter, wrote that he was continuing to support the MPC in its “fight against inflation” and that “to that end, as I announced to Parliament in 1 March 2007 overall headline settlements for public sector workforces covered by Pay Review Bodies are to be less than the 2 per cent inflation target in 2007-08.”
So public sector workers can look forward to a real-terms pay cut of – currently – just under 3% this year? We are really looking forward to seeing how that one plays out with the unions – particularly as inflation isn’t just going to lie down and go away. Already nurses have backed calls to take industrial action unless the government improves on its 1.9% pay offer.
Elsewhere on the BBC site, Evan Davis on his blog, shows that the mainstream is finally waking up to the fact that inflation is a problem. He warns that if inflation persists “it would imply that interest rates had perhaps been ‘too low’, that the borrowing we have done on the back of low interest rates was less affordable than we thought, that the house prices we have paid on the back of easy borrowing are unsustainably high, and that any sense of consumer wealth deriving from higher house prices is a mere illusion.”
Phew! Couldn’t have summed it up better ourselves.
So what’s ahead for interest rates? A further hike in May is almost certain – the money markets are already pricing in a further hike to 5.75%. And as Edward Hadas on Breakingviews.com points out, “whispers of 6% by year-end are now starting to be heard. But while that would be the highest rate since 2001, it might not be enough. After all, 75 basis points of increase since last August seem to have done little. Once inflation is let loose, it is not easily tamed.”
We don’t disagree with him. But we’re betting that at the next hint of inflationary pressures easing, the markets will immediately dive back into complacency mode, and the talk of 6% will be relegated to the back benches again.
Don’t be fooled. Inflation may have just sprung its biggest surprise yet, but it won’t be the last – not by a long chalk.
Turning to the stock markets…
Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: Money Morning.
In London yesterday, the higher-than-expected CPI figure plunged property stocks, banks and retailers into the red. However, a solid start on Wall Street saw the FTSE 100 index pull back some of its earlier losses to end the day at 6,497, an 18-point fall. For a full market report, see: London market close.
Elsewhere in Europe, the Paris CAC-40 ended the day 3 points lower – at 5,858 – whilst the Frankfurt DAX-30 was 10 points higher, at 7,348.
On Wall Street, stocks closed mixed: the Dow Jones was 52 points higher, at 12,773; the tech-heavy Nasdaq fell 1 point; and the S&P 500 rose 3 points to 1,471.
In Asia, the Nikkei added 139 points to close at 17,667 today, with property stocks leading the gains.
Crude oil had climbed to $63.33 this morning, whilst Brent spot was at $65.70 in London.
Spot gold was at $688.40, up from $686.70 in New York late last night, and silver had risen to $13.97.
And in London this morning, record company EMI announced that a cost-cutting plan was progressing faster than expected and predicted that a measure of profit should beat analysts’ expectations when it announces its results next month. Shares in the company, whose artists include the likes of Coldplay and Robbie Williams, had climbed by as much as 4% in early trading.
And our two recommended articles for today…
Where to invest as the oil price rises
– Whatever has been driving the oil price higher of late, there is one investment which becomes more profitable whenever crude gets more pricey. If you’d like to know where the RH Asset Management team think the best opportunities in the energy sector are to be found, click here: Where to invest as the oil price rises
Who will be hardest hit by a US slowdown?
– As the dominant global export destination, any spillover from the weakened housing market to the rest of the US economy will have global repercussions. To find out which exporters would suffer the most, see: Who will be hardest hit by a US slowdown?