The continuing rise in UK consumer inflation -- to a 3-year high of 5.2% for CPI, and a 20-year high of 5.6% for the broader RPI -- is set to have a number of unexpected consequences. Stephanie Flanders has a good summary on the BBC website.
September's CPI is used to calculate the inflation adjustment for social programmes for the coming year, so this is good news for pensioners, but bad news for the government, which will have to stump up the extra cash, adding to the budget deficit. Various welfare benefits will also be adjusted, with the result that those receiving such payments are likely to see a significantly larger increase in their incomes next year than those who are working. At least at the margin, this will make it more difficult for the Government to achieve its stated goal of reducing the number of people on benefits.
These minor perverse effects might not matter if there was any evidence that the Bank of England's ultra loose monetary policy was actually working. But as Governor Mervyn King admitted in a gloomy speech in Liverpool last evening, and as the latest MPC minutes confirm, such evidence is scanty at best. Very much the opposite, in fact: the case that the Bank is stoking inflation without doing anything to improve growth prospects continues to build.
Let's start with inflation. The Governor continues to argue two things here: that the rise in inflation is the result of factors outside the Bank's control, and that the worst will soon be over, with inflation falling back sharply in 2012. Looking at the first of these, the Bank's task was certainly made harder by the VAT rise at the start of the year, but the Governor also likes to cite international factors such as commodity and energy prices as key drivers of current price pressures. This argument is badly undermined by the fact that UK inflation is now by some distance the highest of any major economy, including Eurozone countries which are way more dependent on imported energy supplies. The UK's poor showing is, of course, explained by the weakness of Sterling, something for which the Bank, after years of low interest rates and money printing (QE), cannot escape responsibility.
As for the contention that the peak in inflation is near, the first point that should be made is that Governor King has been saying that for quite some time, so people are entitled to be sceptical. This time he may well turn out to be right, if only because the VAT rise will fall out of the year-on-year inflation calculation in January. However, the common media trope that the "squeeze on family budgets" will ease in 2012 is almost certainly wrong. Even if inflation falls all the way to the Bank's 2% target over the next 12 months, that will still outpace the likely gain in earnings. The fall in living standards imposed by this year's inflation surge -- the second in only three years, as Stephanie Flanders points out -- will not be recouped any time soon.
This fall in living standards, in turn, almost certainly explains why growth is so stubbornly resisting the Bank's persistent attempts at stimulus. For sure, the UK economy faces other headwinds, including the collapse in growth in the Eurozone and the tightened credit standards of the major lenders. However, consumption is the main driver of the economy, and it's hard to see how it can be revived as long as real incomes and consumer confidence are being decimated by inflation.
Stephanie Flanders, in the piece linked above, makes an interesting point in this regard:
But some, like Richard Jeffrey at Cazenove, think the causation runs at least partly the other way; growth has been slow, because incomes are being squeezed and households have less and less to spend.
Spending by households was actually 9% higher, in cash terms, in the second quarter of 2011 than at the low point of the recession. But in real terms, spending has barely risen at all - the level of spending is just 0.1% higher than in 2009.
You'd like to think that Mervyn King is at least giving some thought to this kind of dissenting view. On his personal website, David Smith declares that after reading the latest MPC minutes, he believes the Bank has quietly given up targeting inflation, and is now targeting growth. Whatever it is that they imagine they're targeting, they don't seem to be doing a very good job of it.
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