Today, the governor of the bank of England had to write a humiliating letter to the Chancellor explaining why consumer price inflation had reached 3 percent. It is now almost certain that the bank will raise interest rates in May. The only question is by how much: 0.25 percent or 0.5 percent.
It was the first time since the Bank of England gained its independence in 1997 that it had failed to meet the government's inflation target. The unexpectedly high consumer price inflation was surpassed by even more appalling retail price data, which also captures changes in mortgage payments. That index is now at a 16 year high and just a fraction below five percent. This index, which more accurately reflects changes in overall prices, will undoubtedly lead to higher wage demands, which will in turn exacerbate the inflationary spiral. The bank of england's measure of core inflation also offered no comfort. In March, that particular index had reached 2 percent.
The central bank now has a stark choice. It has to decide between reasserting control over inflation, or protecting the housing bubble. It cannot do both. As the Bank of England admitted in its letter to the Chancellor, the recovery in consumer credit during 2006 has contributed to higher consumer demand, and ultimately higher inflation. This can only be curbed by higher interest rates. As we all know, nothing kills a housing bubble than tightening credit.
Nevertheless, the Bank of England's letter expressed extraordinary complacency about wage growth. It suggested that wage pressures have not yet materialised. In a narrow backward looking sense, that might be true. However, with the retail price index running at 5 percent, and a tight labour market, workers are unlikely to accept real wage cuts implied by higher inflation and moderate wage growth.
Going forward, the Bank of England will regret any attempt to moderate the inevitable increase interest rates in the vague hope that workers have not noticed rapidly rising prices. If the monetary policy committee acts timidly in May and justs hike interest rates by .25%, this may well keep the housing bubble afloat for a few months longer. However, it almost certainly won't bring inflation back down below 3 percent. Higher wage growth will see to that. Inevitably, further interest-rate hikes will be forced upon the bank. The Bank of England needs to show that it is serious about inflation. Only a 0.5% increase in May will do that.
0.5 percent in May? I'm convinced.
ReplyDeleteThe bank of england MPC is too spinless to consider a 0.5 percent hike. Your analysis might be right in a narrow economic sense, but it isn't realistic to expect anything more than 0.25 percent, if that.
ReplyDeleteLets not forget we have just had an MPC meeting and what happened?
Nothing.
UPDATE 1-Red faces for forecasters as UK inflation surges
ReplyDeleteBy Christina Fincher
LONDON, April 17 (Reuters) - A surprise acceleration in British inflation has caused blushes not only for Bank of England policymakers but also for dozens of City economists paid vast sums of money to forecast data.
Figures on Tuesday showed inflation surged above 3 percent in March for the first time since comparable records began, prompting Britain's central bank to write an open letter to government explaining itself for the first time.
The Bank's failure to keep inflation within one percentage point of its two percent target has already drawn criticism from opposition politicians and trade unions.
But economists are not likely to join in. Not one of 36 polled by Reuters forecast inflation would rise so high. More than half expected it would either hold steady or fall.
Surprises every now and again are part-and-parcel of the business but forecasters seem to be making a habit of them.
Only one of 50 economists correctly predicted interest rates would rise in January and a surprise rate hike in August last year caused similar shock waves.
So is it simply that the economy is becoming harder to forecast? Yes, say many, who blame last year's energy price spike, choppy asset markets and even the weather for making economic forecasting more difficult.
``Forecasters are going through a particularly bad patch at the moment,'' said Michael Metcalfe, senior strategist at State Street. ``Volatile commodity and energy prices along with extreme temperature variations are making it harder to make seasonal adjustments, not just in the UK but in the U.S. as well.''
CREDIBILITY ON THE LINE
It is not just private sector economists that are having a tough time. The Bank of England's own forecasters also seem to be struggling.
In its inflation report last November, the Bank signalled interest rates may not need to rise above 5 percent to steer inflation back to target. Now, money markets are pricing in rates peaking at 5.75 percent.
``Inflation has risen higher and is looking sticker than we and almost everyone else expected,'' said Ross Walker, economist at RBS Financial Markets.
``Demand has been surprisingly strong and, since so many people have fixed-rate mortgages, it may be that monetary policy is taking longer to have an effect.''
A Reuters poll conducted after the data showed economists giving a 35 percent chance that rates will rise to 5.75 percent this year. This is more hawkish than the previous poll but still less than money markets which are pricing in such a move with an almost 100 percent certainty.
Bank of England Governor Mervyn King reiterated his confidence on Tuesday that inflation would fall sharply in the coming months. City analysts also stuck to their guns that the March reading was a blip and inflation would soon retreat.
And Chancellor of the Exchequer Gordon Brown
But can these forecasts still be trusted?
Over the past month, a raft of data has indicated the Bank is facing a more prolonged battle with inflation than it expected. Factory gate prices have picked up, house price inflation has gathered pace and retail sales have also rebounded after a surprise dip in January.
To be fair, the Bank has issued many health warnings over the accuracy of its forecasts, noting uncertainties over the economic outlook have increased. On this point, at least, it has proved accurate.
.5 percent, you are obviously not a home owner otherwise you would realise that people who just wanted to get a home for their family are getting screwed by the starbucks crowd !
ReplyDelete