For more than a year inflation has been well above target. It rose to nearly double the 2% target last month, whilst RPI inflation is almost 5%.
None of this should come as a surprise to the MPC members. After all, some of us have been forecasting this for more than a year, warning that there was bound to be a prolonged period of above target price rises if the Bank kept interest rates down so low and created more money, driving the value of the pound down.
It is difficult to believe that the hand picked economists on the MPC were unaware of these forecasts, or unable to see what was happening to the pound, to world commodity prices and to public sector taxes, fees and charges. So it seems more likely that the MPC have been running their affairs with a different end in view. It looks as if they have given greater priority to helping secure more growth and recovery, than to keeping prices down.
This should require a change of requirements imposed by Parliament and the government on the Bank, and a change of reporting based on new targets. If the Bank’s main concern is to issue enough money to avoid slow growth or double dip, let’s have that as a target, measure it, and hear from the Bank how they are going about it.
The constant question now to those who argue for higher official interest rates is Why do you want to damage the recovery? If you ask why they think this would be the result, they tell you that higher rates would reduce demand, as borrowers have to pay more interest and therefore have less to spend.
It is not quite as simple as that. Many borrowers are on fixed rates. Most businesses and many mortgage holders are already paying rates far higher than the 0.5% official rate. Meanwhile savings rates, also higher than the 0.5% , are nonetheless depressed. If rising official rates took savings rates higher as well, then savers would have more money to spend.
We should not assume that all borrowers have a bigger propensity to spend than savers. Some borrowers are using the advantage of low rates on floating rate debts to accelerate repayments. In other words they are saving more. Many depositors are on modest incomes. They would want to spend extra interest if they earned it.
Traditionally raising interest rates does tighten money, so that should slow an economy. However, when you have as damaged a banking system as we have with as little new credit for business as we see, the official interest rate is not having such a big impact on the outturn. The government and its banking regulators should be trying to find ways of allowing a bit more credit growth in the business sector to fuel the recovery. This is not mainly about the interest rate. It is about regulation of cash and capital.
The best way of taking some inflationary pressure off is to allow a modest move up in the pound. Indeed, in the last few days when markets have wondered if an interest rate move is closer, sterling has risen. It appears that higher interest rates would help. It is true exporters would not have such advantageous prices, but they would get some compensation from cheaper imported raw materials and components.
What the MPC may come to realise is that at a certain point rising inflation is self defeating. If wages remain under strict controls and inflation rises, there will be a sharp squeeze on living standards and less spending power as a result of high price rises. If wages started to rise to catch up with prices, we would be into a difficult inflationary spiral.
In a year’s time some of the pressure may be coming off. When VAT and other public sector fees and charges drop out of the rising numbers it will help. If at the same time Asian inflation is coming under control, so will that. We still have to get there. The VAT rise will be in next month’s figures. So will the higher petrol prices. That fuel tax moderator might come in handy at taking some of the shine off the large price increases at the pumps. The Bank, as always, is in danger of doing too much too late. Sometime this year it might fight last year’s battle against inflation which it has already lost.