At about the time you should be receiving this, Alistair Darling should be getting a knock on his door. He will hear the dreaded words, “There’s a letter for you, chancellor.”
Okay, it may not be exactly like that, but however it is delivered this morning our chancellor should be reading a letter from Mervyn King.
As widely expected, and as first predicted here last year, inflation has risen by more than one percentage point above target inflation. And thus, we are in letter writing territory.
You may recall last year, when the last letter was sent, Mr King said he had expected to write many more letters than he did.
Inflation will inevitably go up and down; what matters of course is the underlying trend.
In fact, core inflation in May, that’s with food, tobacco and energy taken out, rose to 1.5 per cent, its highest level since October last year.
It does seem a little rich though, ignoring oil and food. It is like saying that if you ignore all the bad news, then actually things are not so bad. And the consumer price index shot up in May from 3 per cent last month to 3.3 per cent – 3.2 per cent had been expected.The retail price index hit 4.3 per cent.
Actually, the hike in the retail price index is not so bad, it was even higher last June. But the consumer price index is now at its highest level ever – although in this case forever only goes back to 1997, when the Office for National Statistics first started compiling the CPI data.
So why were prices up so high this time? The ONS said: “Upward factors included housing and household services due to gas, electricity and other fuels. Gas and electricity bills were unchanged this year but fell a year ago and the price of heating oil rose this year but fell a year ago, in part reflecting the rise in the price of crude oil this year.”
Then books, newspapers and stationery also rose by more than a year ago, and foreign holidays, where prices rose this year but fell a year ago, added to the tale of woe. The ONS said: “The upward effects were partially offset by a downward contribution from recording media, in particular pre-recorded DVDs.”
With producer prices going up, up and away, it does seem likely inflation will not be coming down soon.
But what does it all mean? Wage inflation remains modest, perhaps this is because trade unions do not have the muscle they used to.
Take a straw poll among economists, and opinions vary.
Capital Economics, for example, reckons that once oil starts rising, deflation will be the threat and is predicting that the next change in interest rates will be down.
Others feel we need rate rises – to nip inflation in the bud. Geoffrey Howe did that; when he was chancellor he upped interest rates in a recession.
But the story is different this time.
The reason why opinion is so divided is simply because we are on a knife-edge.
The combination of the credit crunch and falling house prices reducing consumer demand, coupled with fears over unemployment keeping a lid on wage inflation, could mean that we are seeing a temporary phase; as was argued here last week, deflation may yet prove to be the danger.
On the other hand, the combination of falling oil, food and the falling pound could ignite inflation.
As we have argued before. Noughties low inflation was partly down to cheap imports from China, and central banks slashed rates. Today’s higher inflation is the flip-side of that. It is caused in part by surging demand from China and India et al.
You can’t celebrate low inflation thanks to China but ignore rising inflation thanks to China and dismiss it as a one-off.
It is a quandary. In fact, it seems the current set of circumstances are unique, with no historical parallel. The good news, there is still time to wait and see.
In the meantime, the Bank of England is probably better off doing nothing.
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