IT is wrong to argue that inflationary pressures are about to return, as many commentators said yesterday after the release of figures showing higher than expected consumer price rises. The reality is that inflationary pressures have always been with us – in past years, inflation took place in asset prices, while consumer prices rose at a more subdued rate. In recent months, there have been signs that some of the renewed asset price spikes, especially in housing, have been caused by excessive liquidity rather than a reassessment of fundamentals.
In other words, inflationary pressures have been back for months; it is hardly surprising that they are now beginning to manifest themselves in consumer prices too, as yesterday’s inflation data revealed. This is not to say that yesterday’s figures should be dismissed. The retail price index excluding mortgage payments (RPIX) grew by an annual 1.9 per cent compared to 1.3 per cent a month earlier. The government’s favourite measure – the consumer price index (CPI) – was up from 1.1 per cent to 1.5 cent. The overall retail price index (RPI) remains in deflationary territory but fell at a more muted annual rate of -0.8 per cent, against 1.4 per cent previously.
While these figures are hardly disastrous and don’t imply that prices are about to surge out of control, there will be more rises to come. Value added tax will go back up by 2.5 percentage points to 17.5 per cent on 1 January, a move which will probably take the CPI over 3 per cent and force Governor Mervyn King to write to the Chancellor of the Exchequer.
It is clear that the Bank of England’s forecasts are no longer to be trusted. The central projection in the May Inflation Report showed the CPI rate falling to just 0.4 per cent in the fourth quarter, a forecast that is turning out to be spectacularly far from the mark. Further rises in inflation in November and December are likely to result in it hitting 2 per cent or higher; analysts, investors and businesses should learn the lesson from this and stop putting too must trust in the Bank’s forecasts.
There are two main issues that everybody should bear in mind. When trying to predict inflation, the Bank’s economists pay too much attention to the output gap, the difference between what the economy would be producing if it were at full capacity and what it is producing today. But while economic slack certainly does matter, the supply of money, the rate at which it is circulating around the economy, sterling’s exchange rate and global commodity prices are even more important. We learnt in the 1970s that there is no contradiction between shrinking economies – and therefore rising output gaps – and rising inflation.
Mainstream commentators still believe “inflation” to be merely about consumer prices while in reality is about something much broader. It is about too much money chasing too few goods, services and assets. It is tricky to know what “too much money” means: you can’t simply look at an arbitrary measure of money because of changing technology and a host of other factors. But when asset prices as well as consumer goods are rising at a precipitous rate, it is clear that something is going wrong.
With the economy now growing again, however feebly, it is important that monetary policy be tightened sooner rather than later. Quantitative easing was a good idea in 2009; it could prove to be an inflationary disaster in 2010.