Sunday, December 20, 2020
Inflation is back - but so far only for house prices
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

For those fearing that inflation will be one of the economic consequences of the pandemic, and the extraordinary measures introduced to combat it, the latest figures showed that it is not happening yet. Far from it. Consumer price inflation fell to just 0.3% last month, admittedly during the second national lockdown, when non-essential shops were closed.

Is this the lull before the storm? Will the economy’s post-Covid bounce, coupled with the inflationary effects of this year’s huge public borrowing and quantitative easing (QE) bring higher inflation? This would not be the first government to inflate away debt.

Before coming on to this question, it is worth noting that the drop in inflation, from 0.7% in October, is producing a significant boost to real pay. When the coronavirus crisis broke, it first looked as if wages were taking a big hit and that people were taking pay cuts to hold on to their jobs. Annual growth in average earnings turned negative in the spring.

That now looks to have been purely a feature of the furlough scheme, when many private sector workers had 80% of their wages paid by the government and their employer did not top up the rest. Overall pay growth has now picked up to 2.7%, with regular pay up 2.8%, both in the August-October period compared with a year earlier.

The public sector is leading the way, with pay growth of 4.1% on a year earlier but the private sector is catching up fast, at 2.3% and rising. In each case, the growth in earnings comfortably outstrips inflation.

Back to inflation. What is going to happen? The most prominent inflation worrier is
Tim Congdon, the veteran monetarist economist, and his Institute for International Monetary Research (IIMR). He says a “reasonable forecast” is that this year’s exceptional growth in the money supply, driven by quantitative easing (QE) will see inflation above 5% in Britain, America and the eurozone at some stage over the next two years.

Annual growth in the UK#s M4 broad money supply measure was 13.1% in October. The annual inflation (deflation) rate in the eurozone last month, by the way, is -0.3%.

Earlier rounds of QE did not lead to higher inflation but this year’s efforts have been bigger and more concentrated. And there is a better prospect of a strong bounce in economic activity than for example after the financial crisis.

The latest consumer confidence reading from GfK, released on Friday, showed that people want reasons to hope, and perhaps that they are ready to spend when they can do so freely again. Though the fuss about the Christmas relaxation of restrictions may have dampened the mood since the survey was conducted, GfK’s consumer confidence barometer showed a seven-point rise, with consumers more upbeat on both the outlook for the economy and their own personal finances.

“It’s safe to say that consumers are looking for good news and they have found it in the form of the UK’s Covid-19 vaccination programme getting underway, which has lifted the mood,” said Joe Staton of GfK.

One ingredient for a potential rise in inflation, the eventual release of pent=up demand, thus looks to be there. The consensus among economists is for growth of more than 5% next year, the strongest since 1988, admittedly after this year’s weakest performance for more than three centuries.

There is quite a wide range of predictions around that consensus, it should be said, with optimists expecting an even stronger bounce and pessimists a recovery from the crisis that will be in low single figure percentage terms. Parts of the country, it is clear, will limp into 2021, amid new tougher restrictions announced in recent days.

The best way to think of the inflation outlook is as a tug of war. On the one hand we have had a huge monetary stimulus whose aim, after all, is to push inflation higher. When it is all hands to the monetary pumps, as it has been this year, it is hard to calibrate whether enough or too much has been done. This is not an exact science.

Without wanting to sound like the famous two-handed economist, on the other hand we will have spare capacity bearing down on inflation. Unemployment will rise further and be a lot higher than before the coronavirus crisis for some time. The “output gap” – economy-wide spare capacity – will be there for a while.

Who will win the tug of war? Inflation forecasts for the coming year do not suggest that most economists are unduly worried about a surge in inflation. The latest compilation of independent forecasts by the Treasury shows that on average the expectation is for inflation of 2% by the end of 2021, in line with the official target. There are a range of views within that, however, with the lowest inflation forecast 0.8% and the highest 3.7%.

The Bank of England, for its part, sees a climb back for inflation to the 2% target, and that it will then stay there. Predicting that inflation will stay at 2% is part of the Bank’s DNA, so there are no surprises there. On Thursday the Bank left interest rates unchanged, though warning that it might spring into action in the event of a no-deal Brexit. “CPI inflation is expected to rise quite sharply towards the target in the spring, as the VAT cut comes to an end and the large fall in energy prices earlier this year drops out of the annual comparison,” it also predicted.

One thing everybody should be able to agree on, however, is that an exceptional monetary stimulus does boost asset prices. It helps explain why, even with the treat of unemployment hanging over them, house prices have recovered so strongly. The Halifax says annual house price inflation last month was 7.6%, the highest since June 2016. The official house price index has prices rising at their fastest rate since the autumn of 2016.

The hand of QE can also be seen in stock markets that have done a lot better that they should have done in the face of the Covid economic shock, in high government bonds prices and ultra-low yields and I am sure in a range of other assets, from art to fine wines and vintage cars. I have been reading that puppy price inflation has soared, though that may be a consequence of lockdown-related demand.

The jury is out on whether inflation for most of the things we buy will rise to high levels, leaving aside the fading possibility of tariffs on imports from the EU, which would be the ultimate exercise in shooting ourselves in the foot. It is quite hard to see a big rise in inflation while the economy remains in the throes of the pandemic and its after-effects, and while it is operating below capacity. The question is whether we are building up problems for the future that lies beyond that.