Yesterday I agreed with much of the Governor’s analysis in his speech. He was right to stress that the high inflation we are experiencing has come from increases in the prices we have to pay for commodities and energy, all imported. He is right, as I have been pointing out, that the big squeeze so far has been not on the public sector but on living standards, as prices have risen faster than wages. He is right, at last, to recognise that inflation will get worse before it gets better, and right to warn living standards will have another bad year. He is right to support cutting the deficit as a necessary part of recovery.
Where he and the Monetary Policy Committee are wrong is to say there is nothing they can do about this imported inflation. They fail to ask themselves why Germany and the US do not have an inflation problem, when they too have to buy energy and commodities on world markets. The UK is different for one very simple reason – the Uk has had a bigger devaluation.
Let’s take a simple case. The price of oil is around $90 a barrel. That is well up from the lows of 2009, but well down from the high of 2008 of over $140. If we were still at $2 to the £1, a barrel would cost us £45. Instead, at around $1.5 to the £1 , a barrel of oil costs us £60. A 25% devaluation against a fairly weak dollar costs us an extra 33% on the price of a barrel of oil.
Yesterday’s speech by the Governor led directly to a 2 cent fall in the value of the pound, or a fall of 1.25%. That means more inflation on all those imports as we pay the price. The reason the pound fell was the markets realised that on the back of the Governor’s speech there would be no early increase in interest rates.
If we devalue more we will make ourselves poorer. We need to curb inflation and end devaluation. At the same time we do need a growth strategy, which incldues regulating the banks in a way which allows or makes them contribute to recovery by sensible lending for needed projects. That is why I have long advocated that the Bank needs to regulate banks as well as interest rates and money, so it can have a policy which both promotes growth and curbs inflation. Briefing that a higher official short term rate stops the recovery is silly. Anyone in the private sector could tell the Bank that the official rate has little impact on lending rates which are much higher, though it does help penalise savers.