Inflation Still Above Market Expectations
- Author Jeremy Smith
- Published May 5, 2011
- Word count 470
The Bank of England will find it very difficult not to take any action in February after another inflation 'surprise', CPI jumping from 3.4% to 3.7%. Inflation has come in above market expectations nearly two-thirds of the time over the past two years. The Bank of England's record has not been any better, with one-year forecasts revised higher in five of the past six inflation reports. Whilst the Bank has argued there are temporary factors pushing up inflation, there is now compelling evidence that inflation is becoming ever more entrenched into the economy. Core inflation jumped to 2.9% and CPIY (that which excludes taxes) also jumped to 1.9%, from 1.6%. Furthermore, CPI is likely to touch 4% in December and with the MPC likely to have an idea of the numbers (meeting falls Thursday before the release), its tendency to deliver half of policy moves in inflation is likely to tip the balance towards tighter policy (most likely a 25bp warning shot).
Behind the scenes, some of the structural forces that have kept inflation constrained over the recent years are now gone. Take clothing and footwear for example. This has been a substantial deflationary force in the UK in recent years, taking on average 0.3-0.4% off the CPI YoY rate in the middle of the last decade. UK clothing price inflation was falling in YoY terms for over 13 years, only turning positive in September of last year. It was always the case that this was going to be a temporary factor in pulling inflation down but, with Chinese inflation having trebled over the past year, then we can be pretty sure that this factor will not return. This will be a substantial loss to UK inflation in the years ahead, with no obvious replacement.
The main deflationary force anticipated by the 'doves' on the committee will be extent of the spare capacity in the economy. Factories lying idle, unemployment remaining high. These, in theory, should bear down on inflation. But the longer time goes on, then the less likely this is to be a factor. Factories cannot be re-opened. The longer-term unemployed lose their skills. To think that this will be a major factor bearing down on inflation on the 1-2 year horizon in which the MPC operates is a diminishing hope.
What would a rate hike achieve? It should be acknowledged that in terms of doing anything with the current inflation issues, very little, given the usual lags in monetary policy. However, it would be a signal to price and wage setters in the economy, along with investors, that the Bank is at least catching up with the underlying inflation forces in the economy. Furthermore, it would also give the Bank the chance to acknowledge that its hopes for the past year to 18 months of a bigger impact from the economic slowdown have proven mis-placed.
Author is a freelance copywriter who writes about forex account
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