Bank of England sets interest rates to keep inflation low to preserve the value of your money,” reads the puff on the front page of the Bank’s website.
But it’s done a poor job recently. The 2.7 per cent annual rise in the consumer prices index (CPI), announced yesterday, is better than last September’s 5.2 per cent. But inflation soon whittles down people’s savings. You would need £2 today to buy what £1 would buy in 1992.
The Bank has overshot its 2 per cent annual inflation target for 35 months in a row. Had it met its target, the cumulative rise in prices since the credit crunch would have been 10.4 per cent. That’s high enough. But the real figure is nearly twice that – at 18.6 per cent.
As usual, “special factors” were trotted out for explanation. The first was a 19.1 per cent rise in education costs, now that the university fees cap has risen from £3,000 to £9,000. Second came higher food prices after bad harvests in the US. Third was dearer energy bills (though the worst is yet to come.)
But these are only part of the answer. The annual rise in the retail prices index (RPI) – which includes housing costs – was even worse than CPI, at 3.2 per cent. And the core rate of inflation, which strips out food and energy bills, rose from 2.1 per cent to 2.6 per cent. Some projections suggest CPI could rise to 3.5 per cent by mid-2013. Inflation seems a lot more stubborn than the Bank predicted.
With wages lagging behind prices, household budgets are shrinking in real terms every year. Consumers will be squeezed even more in 2013. So where is the debt-busting, book-balancing, recovery-fuelling new growth going to come from?
Certainly not from many businesses – they’re also being hurt by inflation. The Office for National Statistics reported that the prices of goods leaving factory gates has remained stuck, while input costs rose by 0.1 per cent. With consumers not spending and costs rising, it is unsurprising that firms are sitting on cash rather than investing.
These inflation figures might explain why the Monetary Policy Committee decided against another round of quantitative easing last week. Sterling jumped on the news, of course, as every dose of the Bank’s easing dilutes the value of the pound. But it was the opposite for shares, as monetary expansion boosts asset prices – though little of it actually gets through to the real economy.
As for the government, inflation allows it to repay its debts more easily, using devalued currency. But then it is largely the Bank of England’s willingness to bend monetary rules that has kept down borrowing costs. Less Bank expansion means less room for George Osborne to manoeuvre.
At some point, we have to take the pain. We had a huge cheap-money, public-borrowing binge and now we are trying to put off the hangover with a hair of the dog. Inflation is a killer. We need to lock it away, and fast.
Eamonn Butler is director of the Adam Smith Institute.