IN the long-term, we are all dead – or so claimed John Maynard Keynes. True, of course, but only in a meaningless kind of way, as yesterday’s dangerously high UK inflation figures demonstrate. For ages now, the Bank of England has been justifying its failure to meet its inflation target in the short-term by repeatedly pointing to the fact that its forecasts suggest all would be well in the medium-term. At first, most commentators were satisfied by this. No longer.
The trouble is that a succession of short-terms must eventually become the medium term (and eventually the long-term, the point the congenitally short-termist Keynes failed to grasp). That time is surely now. Every month for the past 12 months, inflation has been above the government’s two per cent inflation target – and every time the message has been not to worry, the overshoot is just due to temporary factors and powerful disinflationary forces mean all will be well. Yet over the past 37 months, CPI inflation has been below target only six times (all between June and November 2009) and above 31 times. It’s a poor record, especially ahead of the Vat rise next month which will put further upwards pressure on prices.
Inflation on the Consumer Prices Index (CPI) hit 3.3 per cent last month, up from 3.2 per cent in October, the highest level for six months. The retail price index was up 4.7 per cent year-on-year in November, from 4.5 per cent in October. Great news if you have a mortgage or credit card debt, as its real value drops and you are effectively allowed to default on part of your debt; terrible if you rely on a fixed income. To maintain the purchasing power of their savings, a basic rate tax payer needs to find a savings account paying 4.13 per cent per annum, while a higher rate tax payer at 40 per cent needs to find an account paying 5.5 per cent, Moneyfacts calculates. The figures need to be even higher if one wants to protect against RPI inflation or for those on the 50p tax rate. There are very few instant access bank accounts that provide such protection, which means that people are wasting their time holding on to cash.
It is sometimes claimed that high inflation is the only way Britain’s massive debt burden, private as well as public, will be eroded in real terms. Others argue it is the only way to tackle the UK’s high labour costs – output per worker fell during the crisis, while wages rose slightly. But this assumes nobody reacts to higher prices – yet UK gilt yields are starting to rise again as investors protect themselves against the ever shrinking pound. Higher inflation will also push up mortgage rates and all interest rates charged to firms and individuals. The more people think inflation will rise, the more they put up their prices and wages in anticipation, and the more inflation actually rises, triggering a self-fulfilling loop. Once an inflationary spiral kicks off, only vicious hikes in interest rates can stop it.
Higher inflation brings with it significant other costs. Real incomes are falling, which means that there is less money left to spend; inflation is a hidden tax. It is all good and well to try and boost the money supply, as the Bank has done, but the benefits of this are eliminated with excessively high levels of inflation. We need higher interest rates and absolutely no more QE – and a strong message of intent from the Bank. Time is running out for the authorities to show that they truly care about keeping inflation low.