Comments: As cooler winds blow, we get that sinking feeling

In spite of recent panics, the US economy seems to be bubbling along and should stay close to its long-term growth rate for the rest of the year (according to leading indicators).

If nothing extraordinary happens in the US then there’s every reason to expect four or even six more 0.25% interest rate rises this year from the FOMC.

If US interest rates rise by at least 1% then surely the MPC will have to raise UK rates at least once or sterling will fall (given the state of our deficits), raising inflation.

The high, March UK inflation figures were no aberration – the RPIX figure of 2.4% was similar to December’s 2.5%. So inflation for the past twelve months has been very close to target.

But inflation in the months of April to September 2004 was actually below the long-term average. Therefore if inflation for those months in 2005 is just equal to the long-term average, the annual rate will rise. Plugging in the long-term average numbers gives RPIX inflation rising to 2.8% by September.

Unless the oil price drops significantly, the MPC could find itself between the rock of rising inflation and the hard place of a falling currency.

But then a single UK rate rise could bring the whole housing market down like a ton of bricks. If that happens, UK consumers that have already stopped borrowing-to-spend might even start saving.

Oh, poor retailers – for you, the nice nineties are well and truly over. (And that's before the other worries about tax rises and unemployment.)

Posted by David Sandiford at May 1, 2005 12:43 PM