The Economy in Peril
Will the Bank of England's fixation with tackling inflation cause it to loose sight of the greater danger?
When the Bank of England announced that it was keeping interest rates at 5%, in the teeth of an increasingly grim economic outlook, the suspicion was that the Monetary Policy Committee knew something the rest of us didn't. Now we know what it was. The dramatic hike in the headline consumer price inflation figures, which leapt five points to 3% in April, shocked even the most pessimistic forecasters.
It now looks almost inevitable that inflation will top 3.1%, causing Mervyn King to write another explanatory letter to the Chancellor. Indeed, with no sign of abatement in rising prices, it's likely to be the start of a protracted correspondence. That's embarrassing for King, but it's likely to be even more painful for British households.
Slowing growth, rising inflation... we've been here before. But 30 years on from the nightmare of the Seventies, King is wary of using the term stagflation. The economy hasn't yet ground to a halt and inflation is still way off double digits. Even so, there's a high risk of things getting a great deal worse – and government hypocrisy is hardly helping confidence.
Witness the hilarious spectacle of Caroline Flint, the luckless housing minister, carelessly displaying a briefing document showing the Government's assessment of a 5%-10% fall in house prices this year, at best. Behind the scenes, meanwhile, she was finalising a package of measures to help first-time buyers. Should ministers really be encouraging anyone to buy in a falling market? Any more of that and they might be done for mis-selling.
A housing collapse would hit an already failing economy hard, but the Government can expect little help from Mervyn King, who has made it clear that his priority is to tackle spiralling prices. Many economists now conclude that rate cuts are now off the agenda for the rest of the year, but there may be real danger in focusing on near-term inflation when a longer-term perspective is required.
The economy is weakening at such a pace that the inflationary winds could turn around very quickly. In a year's time, we could be worrying about deflation, not inflation.
The bank must talk tough to prevent expectations of rising inflation from becoming a self-fulfilling prophecy. But the big risk of taking this line is an unnecessarily hard landing for the economy.
If it holds rates too long, the Bank will kill inflation but also kill the chances of a swift rebound in 2009. That will have grave consequences for everyone, not least Gordon Brown.
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