Is Inflation Out Of Control?
The surge in prices took even the Bank of England by surprise. But markets may be signalling a sea change.
The unmistakable message from the recent inflation figures is that it's going to get worse before it gets better. Soaring food prices took inflation, measured on the consumer price index, to a 16-year high of 4.4% – more than double the Bank of England's 2% target. With swingeing increases in gas and electricity bills still to feed through, there's every likelihood the upward charge could hit a startling 5.5% in September.
The figures are nothing less than shocking and the Bank's quarterly inflation forecast – in which governor Mervyn King delivered his gloomiest assessment of prospects yet – will make uncomfortable reading in Downing Street. King forecast that UK growth would be broadly flat with a possibility of "a quarter or two of negative growth". We should steel ourselves, he said, for "a difficult and painful adjustment".
The figures are merely telling us what we already know – we are still in a jam. In fact, to many Britons suffering double-digit price rises in basic foodstuffs and fuel, the official figure probably feels too low. But this latest price rise will badly hit Government finances. Public pensions and state benefits will be indexed upwards, pushing spending way above expectations. Result: yet higher borrowing.
Meanwhile, the Bank's interest rate dilemma is intensifying. The Monetary Policy Committee is performing a bold hope trick by taking no action on rates, while insisting it remains committed to its 2% inflation target. The hope is that a combination of slowing economic growth and falling commodity prices will bring down inflation without the need for a painful hike in interest rates.
Certainly, the Bank cannot risk a cut in rates until the back-end of the year at least – even if that means a deeper and longer economic slowdown.
Yet there is room for optimism. The fall in oil and commodity prices seems to be accelerating. The Russia-Georgia conflict should have sent the price of oil soaring, but it remained below $115 a barrel. Classic investment theory has it that when a price fails to react to bullish news, it's a sure indication that the next big move is down.
Certainly, stock markets – which have done well recently despite the gloomy economic news – seem to smell a change of mood. In addition, when inflation does start falling, it is likely to come down fast – increasing the scope for rate cuts. So watch the oil price and keep the fingers crossed.
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