Inflation needs to fall before rates can rise

Ross Westgate
SO another week but the focus is the same. Where’s inflation going and what’s the impact on the consumer and growth? Last week the Bank of England said inflation could hit five per cent and tomorrow April CPI could rebound to an annual rate of 4.4 per cent.

For the fourth quarter in a row the bank also guided lower on growth and today the Item Club talks about consumer spending set to remain below pre-recession peaks until at least 2013.

High inflation driven by the VAT hike and increases in food, energy and clothing is one cause, the other is the weak earnings growth. This will be highlighted again with Wednesday’s Labour market figures.

As a result the ITEM Club says “the squeeze on household budgets is only going to intensify this year” as we “experience a second consecutive year of declining disposable incomes”.

In this environment it’s very hard to see how the bank can raise rates. Growth is the key and the key driver of growth in the last 30 years, the consumer, is completely under the cosh.

In fact I believe that until current inflationary pressures ease the Bank can’t think about raising rates. Mervyn King has said he doesn’t do “gestures”, which means when rates do go up from this ultra low level he’d like it to be the start of a normalising cycle.

The only way his inflation target could be achieved appears to be driving the country back into recession.

Rates can only go up when we believe the consumer can deal with them and that means when some of the pressures have started to ease. As it’s unlikely to come from wage settlements, which the ITEM Clubs says are only going to increase very slowly given the significant slack in the economy, the relief will have to come from lower inflationary pressures.

In that light the recent fall in commodity prices is most welcome, but the evidence of so much speculation in these markets and the increased volatility means it’s difficult to work out where prices will be at year’s end.

On top of this there is Eurozone peripheral debt. The greatest fear is the risk of a second great bank crisis at a time when we’re far less able to deal with it. When UK rates hit their current level, Capital Economics Roger Bootle suggested they might stay there for five years. We’re nearly half way through and while I can’t say I agree with him, I am beginning to envisage a scenario where he could be right.

Ross Westgate is co-anchor of CNBC’s Worldwide Exchange.