I am aware that the Office for National Statistics says that consumer price inflation rose in February in data announced this morning.
The increase is 0.4%. This is not a lot, but it is not the expected direction of travel.
I am aware I have confidently stated that inflation will tumble this year. I remain entirely of that opinion now. The reason is straightforward. As a matter of fact, all of the UK's inflation indices are calculated by comparing the price of a bundle of goods in the current month with the equivalent bundle of goods 12 months previously. There is nothing more sophisticated to the process than that.
The biggest cause of inflation in the U.K. of late has been the external economic shock created by war in Ukraine. This begin in February 2022. That means that from March onwards price comparisons are between events after war started with other events after that war started. That means that in the next month or so we should begin to see bigger falls in the rate of inflation as the impact of the war in Ukraine begins to diminish with regard to the calculation of this index.
Is today's data indication of a case for concern in that case? No, in my opinion. It is just an indication that this effect has yet to get going.
I remain quite sure inflation will tumble. We need a 1.5% rate cut now.
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Yes.
Inflation data tells us about historical price rises – not what prices are going to do. Today’s interest rates are the cost of financing business in the future….. not “compensation to lenders for past erosion of capital due to inflation”.
Inflation forecasts are just forecasts… but it is the best we have. The OBR suggests that the inflation rate 1 year from now will be 2.5% and 2 years from now 0%. This means that on a 2 year view (the sort of period we think it takes monetary policy to have a meaningful impact) prices will rise 2.5% – or, on average, 1.25% each year.
So, if rates stay where they are (and today, 2 year swap rates are 4% implying that the market thinks that, on average, base rate will be 4%) that implies a real cost of borrowing of 2.75%. In the current environment that is absurd.
There has been a lot of ‘to and fro’ on this blog about the banking crisis. My view is that UK banks are in a much better place than they were in 2008….. but if the BoE insists on driving the economy into the ground then we will have a banking crisis.
Agreed
Forgive me, but “UK banks are in a much better place than they were in 2008” I do not dispute; but in 2008 they could scarcely have been in a much worse place; therefore, I do not find the comparison of much comfort. What matters is whether there is a threat to confidence and liquidity, and if there is a threat, the level and speed of the impact and the resilience of the system. I do not have the answers to these queries, but candidly on past performance, and the level of understanding and judgement I have seen displayed on a whole range of economic and financial issues, I do not see much evidence of proven resilience in most of the measures pursued by either the BoE or the Government. I do not predict the worst will happen, but my confidence in the wit and wisdom of the putative authories is low, and suggests to me they are relying rather more on the fragile mettle of what Machiavelli would have described as ‘fortuna’, than on the lasting effectiveness of their short-termist activities.
Point taken, 2008 exposed a system in very poor shape.
Are the people driving the bus any better today? Almost certainly not. However, some “lessons have been learnt”.
First, there is a lot more loss absorbing capital – mainly common equity but also AT1 bonds – about 3x as much as prior to 2008. That means losses have to be much greater before senior unsecured bond holders (the vast majority of bonds) and depositors take a hit (or a government bailout becomes required).
Second, there are virtually no unsecured credit risk between banks anymore. (Uncollateralised) Interbank lending is tiny compared to 15 years ago, transactions between banks are almost all novated to a Central Counterparty that takes plenty of collateral from its members. So, if there is a problem with one bank there will not be direct contagion to others and markets in securities can keep functioning with worries of the creditworthiness of the counterparty.
Third, Liquidity Coverage Ratio rules have improved the liquidity position of banks so should be much more able to withstand a bank run…..
BUT (and this is a BIG BUT) the evidence from the US and Switzerland is that this may not be enough. The regulations make assumptions about deposit outflow in a crisis… and these may have made sense 15 years ago but the speed at which money gets pulled has increased due to better information and technology (no queuing in the rain for cash at a branch with tellers on a “go slow”… just click your mouse).
If one accepts that we need credit provision for the real economy and maturity transformation as part of that then banks will always be with us and always risky. However, there are a few things we could do…..
First, set up a new Girobank and link it into NS&I. There has to be a 100% safe institution where those unwilling to take any risk can save/park cash etc. The Post Office would be the branch network.
Second, overhaul the deposit insurance scheme. Higher limits for companies are required but this should be financed by banks.
Third, review LCR rules to reflect the realities of retail deposit flight (as seen at SVB, CS, First Republic etc.)
Fourth, alter the pay structure. Current thinking is that base salaries should be high and bonuses smaller to discourage risky behaviour…. but it has (a) failed and (b) created huge fixed costs. Better to have more modest salaries and pay bonuses based on performance…. and not paid in cash but (say) AT1 bonds with below market yields (or similar) that mature in (say) 5 years time. At least when there is a problem this becomes loss absorbing capital.
I know that this is not a perfect solution…. but it might just help a bit.
I was about to say I had seen Andrew Sentance saying there needs to be a 0.5% rate *rise* – and then saw on twitter you had already seen that.
How do these people sleep at night?
Sentance is an idiot.
I find him loathsome and I can honestly say that os very few people
I understand and don’t disagree with the way you have explained this Richard, and I know how inflation measures are calculated.
Notwithstanding that, I have noticed that some things have been subject to enormous price rises recently. The various railway magazines I read monthly have all gone up recently, and the publishers cite increased paper costs as the reason. Own brand fresh orange juice in my local supermarket (a large national chain) is now £1.70 a litre. The last price I remember for it was £1.20. The same supermaket chain has also hiked the price of my usual weissbier from £1.80 a bottle to £2.25 (ie. a 25% increase). Whilst this may be not unrelated to cereal prices, the same stuff is still £1.80 in another large supermarket a few miles away. A first world problem the cost of my beer may be, but these are not the only prices I have noticed rising recently. Cynic that I am, I can’t help thinking multinational producers and/or major supermarket chains may be increasing their margins at a time when, plausibly, they can claim their costs have risen.
Prices will rise this year
Right now at around 10%. But that rate of change will fall. Next year it may be 2.5%, and still falling.
That is what falling inflation means
Unless it goes negative prices will not fall
I feel your pain Rob – even a bargain flapjack has gone up from 29p (Feb 2020 price) to 39p now. At least I’m paying more for the same product.
The reason I say that is that Council Tax has gone up just under 5%, and my income tax has gone up over 1000% this year (but I was just over the cusp of the basic threshold before). If I was paying more for the same I’d grudgingly accept the situation, but I’m paying more for less.
You make an important point.
First, inflation in the “basics” is higher than overall inflation. Those on low pay are feeling the pinch doubly so.
Second, higher prices don’t magically come out of nowhere – companies CHOOSE to raise prices. Why do companies hike prices? Because they can! – well at least some of them can. Do not forget price gouging as an important part of inflation.
Do the current MPC actually intelligently debate the likely consequences of their options – or do they simply copy the Fed?
I think a couple of the external members do debate the issues
As for the rest? Nodding donkies might do more thinking
We need unemployment and we need it now! And to get there, we need to take the ‘medicine’. According to those least affected by crippling interest rates.
The whole Jon Stewart clip is good, but Larrry Summers @ 2 min 11 saying that mass unemployment is needed to contain inflation against the backdrop of his luxury Caribbean holiday resort is just like a big two fingers to the US working class.
https://youtu.be/SHUUTpxmzxA
(a couple of swear words btw)
The general economic media opinion seems to be that the 0.3% rise in inflation will mean interest rates will almost certainly now rise tomorrow, by at least 0.25% (the US Fed has already set the precedent). And so it goes on.
Agreed
But it will be a mistake
I’m worried the Bank of England will blindly follow the fed here. It appears neither fully understand inflation, which is caused by either supply side (cost push), or demand pull. Interest rates will impact the demand side only, and the impact will only be seen in 12-18m time. If the majority of your inflation was caused by supply (war, supply chain, Chinese zero COVID); then they will blindly overshoot the target interest rate (i.e the rate of interest at which inflation will fall gradually) (they may already have!) And as a result cause one major recession/depression to be played out next year. It worries me there’s never any proper analysis where exactly the inflation is coming from before blindly executing rate hikes.