Sunday, September 19, 2021
There's a real risk that the inflation cat is out of the bag
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. Not to be reproduced without permission.

As inflation shocks go, the one unveiled a few days ago was quite a big one. The jump in consumer price inflation from 2 to 3.2 per cent in August was, according to official statisticians, the largest ever recorded increase in the rate, though the data only goes back to January 1997.

For those who still follow the retail prices index, and I know from my mailbag that many do - though the Office for National Statistics would rather they did not - inflation on this measure rose to 4.8 per cent, from 3.8 per cent. The RPI is still widely used, including for student loans (RPI inflation plus 3 per cent).

There were temporary factors in the rise in inflation. August this year compared with the Eat Out to Help Out price cuts of a year ago, courtesy of the chancellor. A rise of 18.4 per cent in used car prices since April is very odd and reflects supply shortages of new vehicles.

There are, on the other hand, many reasons to think inflation will go higher. Food prices rose by 1 per cent last month alone and while the increase over 12 months was a mere 0.3 per cent, that annual rate seems bound to rise. Similarly for household energy prices. Gas prices last month were 4 per cent down on a year earlier. They are now on the up

“Pipeline” measures of inflation, meanwhile, are also increasing. Industry’s raw material and fuel prices last month were 11 per cent up on August 2020, up from 10.4 per cent. Output or “factory gate” prices were up 5.9 per cent, from 5.1 per cent.

Other countries are experiencing high inflation. In America there was reassurance that consumer price inflation dipped, but it only fell to 5.3 per cent from 5.4 per cent and remains high. The UK’s inflation rate was the highest since March 2012, but Canada’s rose to an 18-year high of 4.1 per cent.

Some of the influences are global, though we have we or two special factors of our own, but the effects of inflation are local. And despite a long list of temporary factors, including the fact that higher prices are concentrated in a few areas rather than across the board, the question of whether the inflation cat is escaping from the bag is a live one.

What does the Bank of England do? Its monetary policy committee (MPC) meets this week and has a decision to make. I got quite excited earlier this month when the governor, Andrew Bailey, told the House of Commons Treasury committee that the committee was split 4-4 last month on whether the conditions had been met for a rise in interest rates.

You may be puzzled by that, for a couple of reasons. Firstly, are there not nine members of the MPC? Usually, yes, but at the time the Bank was awaiting the appointment of its new chief economist, Huw Pill, following the departure of Andy Haldane. Pill will be voting this week. Catherin Mann also joins the committee, replacing Gertjan Vlieghe.

Secondly, if you think you do not remember a 4-4 split vote on whether to raise interest rates last month, which would have shocked financial markets, you are right. This is because what the governor was talking about was the Bank’s policy guidance.

This, first set out a year ago, was that the MPC will indicate whether the “necessary” conditions have been met for a rise in interest rates, before deciding whether those conditions are “sufficient”. Four members, including Bailey, thought the necessary conditions had been met last month, and that could increase further this week.

Getting to “sufficient” is another story. The Bank is expected to raise rates but not for some time. Financial markets have priced in an increase from 0.1 to 0.25 per cent, but not until the first quarter of next year. A rise to 0.5 per cent is priced in by the end of 2022, at which point the process of reversing quantitative easing (QE), by not reinvesting the proceeds of maturing gilts, could begin. If you think that’s a snail’s pace, snails could reasonably complain that they are never that slow.

The inflation shock is one thing for the MPC to consider, but it will also have the weak July gross domestic product figure and the tax hikes announced last week to take into account.

The decision this week will be whether to proceed with the remaining QE voted on in November last year, with a promise that it would continue until the end of this year. That final tranche, of £150 billion in all, with perhaps £50 billion to go, should certainly have been stopped two or three months ago. One MPC member, Michael Saunders, voted to cease last month. If the others did so now, and market expectations are that they will not, it might signal that they had been shocked into a change. That, in turn, could make them reluctant to shift.

We should not be too harsh on the Bank. In America, where inflation is higher than in the UK, markets are waiting the Federal Reserve’s decision on tapering its QE purchases, not stopping them entirely. There is a similar picture in the eurozone, where inflation rose to 3 per cent last month, and the European Central Bank is trimming but not halting its asset purchases. For some reason Christine Lagarde, its president, does not want to call this tapering.

“The lady isn’t tapering,” she said earlier this month, channelling Margaret Thatcher. Whether or not the Bank of England completes the current QE programme, it is unlikely that there will be any more in this bout of monetary support.

It may be, of course, as many would argue, that central banks are collectively making an error, by operating ultra loose policy even as inflation starts to take hold. Capital Economics, the consultancy once known for declaring the death of inflation, has been running a series of research notes on the issue, and will soon publish a research note, “The rebirth of inflation?”

Its verdict is that for most countries the current inflation upturn will subside. But, it warns: “A new era of higher inflation is most likely to emerge in the US and perhaps the UK.” This will not be a re-run of the 1970s but, rather sustained inflation of 3 to 4 per cent. That would be getting close to double the official target of 2 per cent and also double the average since Bank independence in 1997. It would be a significant problem. These are choppy waters.