Inflation and borrowing up.

 

             Inflation has continued its rapid upwards movement. The RPI was 5.5% higher in February 2011 than a year ago, and the Bank’s target rate CPI was 4.4% up, or 120% above the 2% target. We are paying the price of the devalued pound, the low interest rates and the quantitative easing. These high prices will squeeze consumers more. The Bank set interest rates which were too low over a year ago, as we discussed on this site at the time.

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43 Comments

  1. alan jutson
    Posted March 22, 2011 at 11:17 am | Permalink

    Income: Squeezed on inflation, squeezed on tax rises, squeezed on savings interest paid.

    The economy needs to grow as we know, but who has the money to spend that will help. ?

    Certainly not those who have tried to do the right thing.

  2. Euan
    Posted March 22, 2011 at 12:12 pm | Permalink

    On the other hand inflation eats away at the debt so it’s good for Osborne- just bad for everybody that doesn’t owe more than they’re worth. All central banks destroy their currency – the Federal Reserve has managed more than 93% devaluation since 1913.

    • grahams
      Posted March 22, 2011 at 5:33 pm | Permalink

      Exactly. The Chancellor and the Treasury want high inflation. In Treasury questions this afternoon, the many planted questions conspicuously avoided any mention of inflation and the one question, from Mr Carswell, was batted away with disdain by the Chancellor. The inflation target is defunct and to claim otherwise is truly hypocritical. Sadly, I suspect that inflation will prove to be the fatal flaw in the Government’s spending,tax and growth strategy.

    • REPay
      Posted March 22, 2011 at 9:18 pm | Permalink

      I believe the equivalent figure for the BoE is 330%

  3. Paul B
    Posted March 22, 2011 at 12:19 pm | Permalink

    So what can be done about it?

    The BoE is independent, but it also manages to escape any accountability. What’s the point of a 2% target that can be missed so easily?

    CPI was briefly below 2% in late 2007 for 3 months. It was then below 2% for 6 months in 2009. Yes, drastic measures were needed at the time. But these measures were taken in 2009 and 2010 with extremely low rates, the provision of billions via liquidity schemes and billions more of printed money/QE.

    We have since had month upon month of inflation above the target.

    It also amazes me the BoE somehow see this as unexpected or down to one-off factors.

    The way I see it: Borrowing billions and giving this to the banks, then printing billions more, means there is a higher amount of devalued money chasing a limited amount of essential resources (i.e. those that go into food, clothing, fuel etc.)

    What result other than inflation were they expecting?

  4. Steve Cox
    Posted March 22, 2011 at 12:44 pm | Permalink

    This is disgusting and disgraceful news, John. And not a peep from Mr. Osborne, who should by all rights be sacking Mervyn King and replacing the entire MPC with people who can actually perform the job with which they have been tasked.

    In case nobody noticed, Zimbabwe’s annual CPI rate is now down to 3% – much lower than ours! Do we really have to descend into their former morass of endless price spirals and currency devaluations, simply due to laxity or ineptitude on the part of the Chancellor and incompetence on the part of the BoE? Recent reports indicate that Mr. Osborne has been spending more time on supporting the Libyan no-fly zone than he has on the economy. This is preposterous, we cannot afford a part-time Chancellor at times like this. Other countries are exposed to the same external inflationary pressures as the UK, but none of them has such rampant and uncontrolled inflation. Mr Osborne and the Coalition should hang their heads in shame, this is a futile return to the Barber inflationary mini-boom of the early 1970’s, which led to 25% inflation a few years later. Mr. Osborne was too young (and his family too wealthy) to remember those evil days (my family were shopkeepers, and I well remember having to update almost all the prices every single week).

    If Messrs Osborne and Cameron fail to get a grip on inflation, the British are headed for a dustbowl future of pensioners eating dogfood and elderly paupers on the street corners. Shame on them both for their lack of any activity in tackling inflation, never mind any proactivity, that would be far too much to ask for.

  5. Ralph Musgrave
    Posted March 22, 2011 at 12:50 pm | Permalink

    According to the BoE, the current so called inflation is mainly due to the 2008 devaluation and the rise in world commodity prices. If they are correct, then higher interest rates over the last year and, an absence of QE would not have made much different to the current so called inflation.

    I say “so called” because inflation consists of CONTINUOUSLY rising prices, whereas the above factrors (devaluation and commodity prices) are temporary: they will work thru the system, and if the BoE is right, price rises will subside in a year or so.

  6. Damien
    Posted March 22, 2011 at 12:52 pm | Permalink

    I would call this stagflation; anemic growth coupled with inflation.

    As you have discussed the push back against the austerity measures from every quarter means the coalition has to operate a de facto policy of devaluation and use inflation to erode the real cost of financing the interest on the deficit.

    The Deputy Governor warned savers last year but unfortunately if you are a retiree investing in equities or commodities may not be a viable alternative.

    It now looks inevitable that interest rates will rise soon however this is not without risk to the economy as now 80% of mortgages are variable rate and soon many more will be tipped into negative equity and are already struggling to service their debts.

    Commercial loans of £500 billion are due to be refinanced in 2012 and have not been accounted for in the previous bank stress tests. I would expect that an interest rate rise cannot be made until the results of the next bank stress test are reported.

    Brent Crude has spiked to $114 and if it goes to $120 that will take it to 5 or 6% of GDP causing more financial instability.

    • Javelin
      Posted March 22, 2011 at 6:11 pm | Permalink

      It’s actually 90% of people on variable rates, up from 60% 10 years ago. To make things worse 30% of people have borrowed more than 3.5 times earnings. To make things worse only 50% of incomes were verified so it’s probably worse than the figures given.

      • Scottspeig
        Posted March 23, 2011 at 9:06 am | Permalink

        I’m actually on a fixed rate (till August) and since I lost a day’s wage and my wife only went part time after having a child, we are at the moment servicing a mortgage over 4 times our annual income! :S

        I’m rather worried about intrest rate increases, but even I’m arguing they need to rise – I just hope the banks don’t abuse it like they have been!!

  7. Javelin
    Posted March 22, 2011 at 1:19 pm | Permalink

    It’s shocking – highest RPI in 20 years.

    As I pointed the BofE MPC has been tracking wage inflation and not price inflation with its interest rates. Here is the link I couldnt post on my iPhone

    http://www.moneyweek.com/news-and-charts/economic-indicators/inflation/05-wage-rises-inflation-indicator-00005

    I had to refresh the page to see the graphic. But the graphic clearly shows that the BofE has not been targeting the RPI but following the Average Weekly Earnings. What is the point of setting the BofE MPC a target if they CANNOT follow it – and instead they robotically follow another target (Average Weekly Earnings). That is to say they cannot follow it because the RPI is out of their control. It makes no sense.

  8. Javelin
    Posted March 22, 2011 at 1:52 pm | Permalink

    Looking at the graphic I posted earlier I’m asking myself the question, Is the BofE MPC even slightly aware they have been following the AWE (average weekly earnings) for many years?

    The MPC claim their interest rates target inflation in 18 months – but its clear to me it doesnt do anything of the sort.

    The RPI is no longer a sensible target – because the contents of the basket are no longer produced in the UK (oil, food, foods etc) and cannot be controlled in the UK. So should they not be targetting the AWE or some other measure?

    Here’s the link again – note this is the only time I have seen this graph with all three indexes, and even the author doesnt spot its significance.

    http://www.moneyweek.com/news-and-charts/economic-indicators/inflation/05-wage-rises-inflation-indicator-00005

  9. Andy
    Posted March 22, 2011 at 2:01 pm | Permalink

    Please excuse my lack of understanding here, I have a basic question on the link between BoE interest rates and inflation.

    The conventional wisdom seems to be that if the BoE puts up interest rates then those people on variable rate or tracker mortgages will have to pay more each month, so their disposable income is reduced, they spend less and inflation goes down.

    My problem with this is that we are often told that there are more “savers” who have paid off thier mortgages than “borrowers” who have not. These are the people who have been erning poor returns on their capital during the current period of low interest rates. So I would think that an increase in BoE rates would lead to these savers getting more interest on their savings, meaning they have more disposable income to spend, causing inflation to go up.

    This would seem to indicate that in fact changing the rates would not have an overall effect on inflation and in truth the inflation is caused by factors outside of the control of the BoE.

    I am sure I have missed somthing important in my understanding of how this is supposed to work, can somone fill me in?

    Reply: Higher interest rates are designed to choke off loan demand, cut credit in the economy and thereby reduce demand. This in turn should exert downward pressure on prices.

    • acorn
      Posted March 22, 2011 at 6:19 pm | Permalink

      Andy. The BoE knows that our banks are still bloated with toxic assets. He is trying to keep super-normal profits in those banks in order to re-capitalise them. The little savers in this nation are supplying those super-normal profits; their investment income is being diverted into the banks’ profits.

      Domestic inflation goes up because demand is exceeding supply. The spare domestic production capacity that would stop prices going up, has disappeared in the recession; the BoE insists that it is still available to keep prices down.

      The value of our currency drops – relative to other currencies – because foreigners don’t want to buy Pounds Stirling; to buy Pound denominated assets in the UK. That includes our government debt. Hence our Debt Management Office is having to offer UK debt at rates nearer 3% above the base rate the banks can borrow at from the BoE. This gives a nice little earner for our banks at the little peoples’ expense. It also allows the government to continue spending more than it sequestrates from the little people in taxes; charges and fines.

      Andy, basically, you, me and our fellow Redwoodians are being screwed every which way. Inflation is bad for you and me; but, it is a God send for the government; the BoE and the banks. Fortunately for the government, the voters are too dumb to know when they are being screwed.

    • Andy
      Posted March 22, 2011 at 6:21 pm | Permalink

      If that is what is required why do we continually hear that the banks are not lending enough and they should be forced to make more loans (for example to small business) or does the above only apply to consumer credit? In any case is the reduction in credit demand not offset by the increase in interest paid out to savers (Who are in the majority)?

      Guess I should go do an economics degree 🙂

    • Pete Chown
      Posted March 23, 2011 at 10:16 am | Permalink

      Thinking about the balance between savers and borrowers is misleading (in this context). Imagine instead that you have an economy which is suffering inflation. Inflation means that money is becoming less valuable. The government wants to make money more valuable, to prevent inflation. One way to make something more valuable is to decrease the supply (supply and demand).

      The government introduces money into the economy by lending it to banks. By changing the interest rate on these loans, it can alter the amount of money the banks want to borrow, because high interest loans are less attractive. A rise in interest rates therefore means a fall in the amount of money borrowed by the banks, which leads to a fall in the money supply, and so—as discussed earlier—more valuable money.

  10. lifelogic
    Posted March 22, 2011 at 2:11 pm | Permalink

    This is not inflation due to a booming economy pushing up demand for goods just devaluation of the pound relative to world commodity prices.

    And then the public sector borrowing was £11.8 billion in February – the highest for the month of February since records began in 1993.
    About £200 per person (including children and the retired) just for one month. Think of it as a deferred additional taxation that will need to be raised later.

    When will Cameron get a grip and set a direction – he will have to eventually.

  11. zorro
    Posted March 22, 2011 at 2:29 pm | Permalink

    All perfectly predictable – the OECD has blessed this course of action. The government will not raise interest rates because of the debt repayments. The message, in short, is if you are sensible you are a mug, and we will only bail out bankers or benefit claimants because we are either owned by them or scared of them……

    Zorro

    • Electro-Kevin
      Posted March 22, 2011 at 10:13 pm | Permalink

      Nail on head.

  12. Brian Tomkinson
    Posted March 22, 2011 at 2:34 pm | Permalink

    Inflation up yet again; no doubt George Osborne and Mervyn King will be cheering that news as the public debt increases inexorably. Borrowing at record levels despite all the smokescreen talk about “cuts”. No surprise there as cash spending, as you keep reminding us is increasing and is planned to increase further. What’s the answer to that – more taxation no doubt. The budget tomorrow will once again be full of further misleading statements whilst the government continues to spend £400,000 a time on each tomahawk cruise missile lobbed at Libya. When are the markets going to realise that this government has no credible plan to stop wasting taxpayers’ money other than to keep taking more and more in taxes?

  13. Johnny Norfolk
    Posted March 22, 2011 at 3:19 pm | Permalink

    It all reminds me when Heath became PM. Things just became worse. Labour were unelectable and in the end along came Mrs T to sort it all out. Cameron & Co just appear to be interested in wars abroad whilst things just keep getting worse at home.They are kidding themselves. Who will save us.

    • lifelogic
      Posted March 22, 2011 at 5:01 pm | Permalink

      It looks like this time we will have to suffer four more years of socialist light then labour then finally we might get someone to sort it out perhaps?

      I assume we with have withdrawn from the wars by then due to a total lack of funds and most sensible people will have left anyway.

  14. Scary Biscuits
    Posted March 22, 2011 at 3:51 pm | Permalink

    It’s not just bank rates that are influencing inflation: it’s government spending.

    Osborne is allowing government spending to stay roughly constant in real terms. This means a nominal terms increase, of about 2-5% per annum, depending on the department. As government spending accounts for about 40% of total GDP, inflation is increased proportionately, which increases government budgets which in turn creates more inflation in a viscious circle.

    The only possible way Osborne could create a budget for growth that he is spinning would be to cut taxes. Unlike his tax increases which diminish growth, produce less than expected revenue and therefore lead to even higher taxes, tax cuts are self funding because they create growth, increasing the overall tax take.

    • lifelogic
      Posted March 22, 2011 at 5:06 pm | Permalink

      “A budget for growth” – perhaps he means growth in Switzerland, Hong Kong, India or China he clearly cannot mean the UK.

  15. Mike Stallard
    Posted March 22, 2011 at 4:22 pm | Permalink

    Taxes for people are now (counting National Insurance) at 40%, 50% and even 60% of income before the VAT/Petrol/County taxes.
    I can remember my Head of Department telling me why he never taught night school in the 1970s. He received precisely 6d an hour!
    And where does all the money go to? It goes into more and more bureaucracy and silly, silly, interfering laws stifling and suppressing and making business life intolerably difficult and, yes, too.
    And then there is the EU.
    No wonder I will continue to be amazed whenever I visit Saudi Arabia/Dubai and see how rich they are compared with us.

    Reply: My understanding is that any move to bring NI and Income Tax together would not extend to charging NI on pensioners and savings income.

    • Paul H
      Posted March 22, 2011 at 6:01 pm | Permalink

      Well it should. These days most of NI seems to be general taxation rather than provide a demonstrable link to benefit entitlement (especially given the regular tinkering with state pension entitlement and the amount of NI contribution required for it). It is not reasonable for unearned income to be taxed so much more lightly than earned income. However, I no longer expect chancellors to be fair – especially those that have no idea what it is like to worry from where next month’s income (of either kind) will come.

      • alan jutson
        Posted March 23, 2011 at 9:08 am | Permalink

        Paul H

        So you think interest on savings made out of taxed earned income, should be taxed higher than it already is!
        What a wonderful policy that would be to encourage people to stand on their own feet, and put money aside for rainy day.
        People with savings are already discriminated against by the benefits system (means testing) your suggestion would encourage more people to spend their money, and rely upon a claim on the state.

    • JimF
      Posted March 22, 2011 at 6:10 pm | Permalink

      A more clever solution would be to hypothecate NHS insurance out of Income Tax, where pensioners would be willing to pay something as users of the NHS, and to issue proper Health Cover Contracts detailing standard of care.

    • lifelogic
      Posted March 22, 2011 at 9:53 pm | Permalink

      So JR savings will only have to suffer 50% income tax and 40% IHT not NI too. So capital will be “stolen” from individuals at perhaps 5% PA with tax and inflation combined doubtless to be tipped down the green/equality drain.

  16. Martin
    Posted March 22, 2011 at 5:14 pm | Permalink

    Could the Bank of England justify our rates for savers being lower than in the Euro zone? Our inflation is higher than the Euro zone and our interests rates lower!

  17. JimF
    Posted March 22, 2011 at 6:04 pm | Permalink

    Print-devalue-inflate.
    This is the easy option. It is the option which Labour would have taken, with a few extra taxes for the “nasty rich”.
    You’ll surely find it difficult to maintain support for this “easy money” policy, as pensioners and savers are handing 5% or more of their cash assets EVERY 12 MONTHS to borrowers who, unbeknownst to them at the time, were borrowing on a 1-way bet.
    The ramifications for the future are bleak; nobody will feel any incentive to save, nor to work for more than they need “for a rainy day”. Those who do work will use their muscle to keep up.

    As said above, somebody tough will need to step in and stop the party.

  18. Andrew Johnson
    Posted March 22, 2011 at 9:22 pm | Permalink

    Thought you all might like to see Guido’s comment of the day.
    “anonymouse in the treasury skirting boards says:”
    March 20, 2011 at 11:21 am

    “The true rate of tax on wages includes Employer’s and Employee’s NI, as both come out of the money required by a business to pay their staff. Employer’s NI is paid on all income and Employee’s continues at 1% after they reach the upper threshold.
    The resulting tax rates are therefore 43.8%, for basic rate taxpayers, 53.8% for middle rate taxpayers, and 63.8% for those paying top rate tax. NI is going up in April so you can add 2% to all these rates.
    Now there’s a challenge for Mr. Osborne!
    John, respect to you, because you have been unfailingly accurate in your analyses of economic matters. The problem I have as a conservative, is that the Tory led Coalition government does not seem to be implementing conservative fiscal policies. Like the Bank of England, it is constantly behind the curve on just about every situation that comes their way. You must be exasperated by the indifference with which your suggestions are being received. Keep going, hopefully UKIP will make them part of their next manifesto, your own party doesn’t seem to be eager to adopt them.

  19. StevenL
    Posted March 23, 2011 at 12:55 am | Permalink

    You obviously don’t understand how the UK economy works with all this whittering about low interest rates. Consumer prices going up is not inflation, what we have is deflation, because the only prices that really matter – house prices – are falling.

    The key is to make house prices go up, and go up as fast as possible, because then consumers can borrow money against the rising values of their land to buy a German motor, a five star holiday to Bali, and Italian leather suite and a new conservatory.

    So the zero interest rates are staying until house price start going up, which given our deflationary demographics and shagged economy will be never.

    • waramess
      Posted March 23, 2011 at 9:50 am | Permalink

      You are the one who fails to understand the simplicity of the economics. Leave interest rates as they are and nothing that has not already happened, will happen.

      Increase interest rates and existing owners of homes that are too financially stretched to afford them will need to sell, or have homes re-posessed, and that will lower the price of housing for first time buyers who might be able to buy from a more stable financial base.

      Further increases in interest rates will replicate the activity until at some stage you will have shaken out of the system all those financial cliff hangers and will have replaced them with financially sound first time buyers.

      In the process you will have created real growth for a multitude of traders and producers who rely on a robust housing market for their existence and you will also have created a good deal of employment.

      • StevenL
        Posted March 24, 2011 at 12:01 am | Permalink

        You won’t get many votes advocating higher interest rates, falling house prices and more repossessions.

  20. Lindsay McDougall
    Posted March 23, 2011 at 1:40 am | Permalink

    Benefits are protected against CPI inflation while wages and salaries are not. Bearing in mind that taxes on wages and salaries help to finance benefits, this situation doesn’t make it easy to reduce borrowing.

    I think that we need to freeze most benefits for 2 years to get a grip on the situation.

    And sack the Govenor of the Bank of England and his MPC.

  21. Gary
    Posted March 23, 2011 at 7:10 am | Permalink

    £8trillion in debt(see Taxpayer Alliance), or debt 466% of gdp(see Mckinsey), anemic growth, growing inflation and govt spending. Default by inflation it will be.

  22. Javelin
    Posted March 23, 2011 at 7:34 am | Permalink

    Allister Heath makes a very good point about risk. Spending readjustments are a low risk necessity. However inflation is currently a high risk strategy being undertaken, by supposedly low risk central bankers. He makes the point that short bouts of inflation are very difficult to get rid of. The main point being the MPC are taking very high risks with the economy. To add a point to that of Mr Heath – central bankers should err on low risk strategies and leave optimisation and the high risks to the politicians.

  23. A.Sedgwick
    Posted March 23, 2011 at 8:08 am | Permalink

    It really is Noddy economics – how any serious economist could expect 1% inflation or deflation as was forecast a year or so back is concerning for the country’s financial future.

  24. Electro-Kevin
    Posted March 23, 2011 at 8:40 am | Permalink

    One wonders why there need to be loans to help first time buyers.

    Those with incomes up to £60k will be elligible.

    If young people on serious wages are unable to afford to buy starter homes then it means only one thing: houses are still well over priced.

    So why is the government intervening in order to keep the housing market artificially over inflated ?

    Is it the same reason that interest rates are being kept low ?

    • Electro-Kevin
      Posted March 23, 2011 at 8:43 am | Permalink

      These will be interest free loans offered from a fund set up by the Chancellor – to assist people who can’t get on the property ladder despite being on £60k per year with base rates already at a paltry 0.5%.

  25. hoondog
    Posted March 23, 2011 at 9:24 am | Permalink

    If what I am reading is correct, I am losing faith that this government has any belief in the free market. This morning I see that Osbourne is planning to loan first time buyers the deposit on a property. I’ve never heard of a more ludicrous policy… talk about putting off the inevitable, at the same time as putting a lot of the poorer segment of society at risk of falling prices. Not to mentioned wasting tax payers money.

    I’ve asked you this before, and I assume the answer is that most of the government are large land/property owners, but why doesn’t the government take heed of some of the advice given by Fred Harrison?

  26. waramess
    Posted March 23, 2011 at 10:09 am | Permalink

    We keep interest rates at zero until our savers have all spent their money and no longer exist. Keynes thinks that is OK because savers are parasites and have nothing to do with the funds available for investment,

    Where I wonder did Keynes think funds for investment came from? From the banks of course where all money is ultimately lodged.

    We are risking a devastating lack of funding diversity in this country if our politicians and Central Banks think that commercial banks can conjure up term funding for investors when their own book of liabilities is becoming more and more unbalanced towards the short term.

    Once again we are looking into the abyss of a banking collapse, this time brought about by the past failures that we have been unwilling to properly address and the imbalances brought about by a lack of equalibrium between borrowers and savers caused by Central Bankers.

    Our masters should start preparing because, no matter how much they might like to save the banks, it will not be an option next time.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, and graduated from Magdalen College Oxford. He is a Distinguished fellow of All Souls, Oxford. A businessman by background, he has set up an investment management business, was both executive and non executive chairman of a quoted industrial PLC, and chaired a manufacturing company with factories in Birmingham, Chicago, India and China. He is the MP for Wokingham, first elected in 1987.

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