If Desmond Lynam was the governor of the Bank of England it is unlikely he would have struck a more assuring note. “Don’t worry. Relax. Take it easy. Sure, inflation is up, but it is all down to one-offs. Take a deep breath, that’s better. There will be no rises in the rate of interest here.”
Well, Mervyn King is no TV presenter, so he said it instead in the natural language of central bankers, econ speak.
“Dear Chancellor,” he said…”World agricultural prices increased by 60 per cent and UK retail food prices by 8 per cent. Oil prices rose by more than 80 per cent and UK fuel prices by 20 per cent. Wholesales gas prices increased by 160 per cent, and UK household energy and gas bills by around 10 per cent.”
Or, in other words – it isn’t my fault.
Inflation will get worse, and higher than the bank of England predicted in its inflation outlook published just a few weeks ago, he said; it could even pass 4 per cent…but.
But…”There are good reasons to expect the period of above-target inflation we are experiencing now to be temporary. We are seeing a change in commodity, energy and import prices relative to the prices of other goods and services. Although this clearly raises the price level, it is not the same as continuing inflation.”
He added: “In contrast to past episodes of rising inflation, money spending is increasing at a normal rate. In the year to 2008 Q1, it rose by 5½ per cent, in line with the average rate of increase since 1997, a period in which inflation has been low and stable.”
So, there is no need to worry then. The chancellor warned that inflation would be with us for a while, because as you know inflation is determined by an annual equation. Even if prices start falling, which, by the way, the Bank does not expect to happen for a while, it will take some time before the annual figures fall back significantly.
But, by the end of next year, the Bank reckons inflation will be back to target.
The big fear relates to pay growth – “This has been moderate up to now,” says Merv, and added, “the prospective squeeze on real incomes associated with higher inflation, together with the reduced availability of credit, is likely to lead to a further slowing in activity this year. This will reduce pressure on the supply of capacity of the economy and dampen increases in prices and wages.”
That’s the ironic thing about hikes in the price of oil. In the long-term, higher oil can be deflationary, as it makes us worse off, leading to lower demand for other goods.
For his part, Alistair said: “Dear Mervyn …I agree.”
Well, he said a bit more than that, but that was his letter in a nutshell.
Apart from one sentence, that is, which had a bit more significance: “To return now to inflationary pay settlements would undermine rather than raise people’s living standards with a damaging circle of wage increases eroded by steadily rising prices.”
So it is all okay then. Inflation will fall back soon, providing wages don’t shoot up, and as unions don’t have the muscle they once had, this won’t happen, and we can go back to slashing interest rates soon.
It is just that there are major flaws in these arguments. To find out why, read the next article.
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