June 2, 2008 | posted by Michael Baxter in rate of interest |

But while people ask of oil, will it, or won’t it, maybe it’s time to look elsewhere.

Inflation maybe be up a tad in the UK, maybe the Bank of England’s governor will be writing to the chancellor soon, and inflation may be showing nasty signs in the Eurozone and US, but the real fears must relate to the rest of the world.

Take Argentina. Officially, prices are rising by 8.9 per cent. That is bad, but wait until you hear this. Today, the Telegraph reported on a claim made by union staff of the statistics office there, that actually the figures are being deliberately distorted. The true inflation rate is 40 per cent, and the country’s government is trying to use inflation as a way of paying off debt, so they say.

Then there’s China. Behind the Great Wall prices are rising by 8.5 per cent, but the official rate of interest is just 7.47 per cent.

In Thailand, inflation has soared to 6.2 per cent, yet the interest rate is just 3.25 per cent.

In fact, according to Bloomberg, in no less than 11 Asian economies real interest rates are negative.

Now we have been here before.  Negative interest rates are not unprecedented, back in 1975 UK inflation was 24.2 per cent, but the rate of interest that year ranged from just under 10 per cent to 12 per cent. So that means the real rate of interest was around minus 14 per cent.

It is nothing like that, but right now in the US the real interest rate is negative too.

The low real US and UK interest rates are leading to falls in the pound and the dollar, which in turn will bring inflationary pressure down the line.  

But on the other hand, high inflation in Asia could eventually make the local currencies fall.

If Chinese inflation continues to outpace US and UK inflation, then at some time in the not too distant future, its currency, the yuan, may look too expensive, and the pressure may be for it to fall, rather than rise as US politicians are demanding.

And back to the UK, last week the CBI revealed its latest retail survey, and it showed that 56 per cent more retailers said that they raised prices this month than reported cutting them.  This is the highest ratio since May 1992.

The trouble is surely this.

For ten years we had low inflation, thanks to external factors – cheap oil, cheap imports from China and India, the Internet enforcing unprecedented price competition.   We became spoilt.  Rates were slashed because inflation was low and cut down rates could be justified.

Governments spent, consumers spent, asset prices leapt in price,  consumer borrowing just rose and rose.

Central banks and policy makers seemed to convince themselves low inflation was down to them.  It wasn’t.

Now, inflation is occurring because the real factors that kept prices down no longer apply. 

Consumer spending at the levels it reached in 2007 is not sustainable.  If it were to continue at that level, inflation would indeed rise.

Inflation remains a threat for as long as policy makers try to see a return to those days.

If instead the economy moves to a sustainable level – with spending less than income, with savings at the level they should be at, given the pending pension crisis, then inflation pressures will ease.  Oil will fall in price, so will the cost of food.

Economic growth should come from investment feeding innovation, not through mass credit card spending.

But do policy makers dare take the necessary steps?