Inflation up to 4.7% - another letter!

The annual rate of UK inflation rose to 4.7% in August from 4.4% the month before, a higher-than-expected jump. Inflation as measured by the Retail Prices Index (RPI) - often used in pay negotiations - fell to 4.8% from 5%. The biggest contributor to this rise was the increase in energy prices which outweighed a number of prices falls. For the third time the Governor of the Bank of England, Mervyn King, was forced to write a letter to the Chancellor explaining why the inflation target had not been met. The BBC site as a nice video feature looking at the content of the Governor's letter. (Link)

Still concerns about 'stagflation'.

The CBI has become the latest organisation to predict that the UK will fall into recession this year. The business group estimates that the economy will shrink by 0.2% between July and September, and then by a further 0.1% from October to December. Its report follows similar warnings from the European Commission and the British Chambers of Commerce. An economy is generally considered to be in recession after two successive quarters of declining output. (Link)

The Governor of the Bank of England has warned MPs that inflation, now at 4.4%, is set to exceed targets once again. Mervyn King said "it would not be surprising" if he had to write to the chancellor next week explaining why inflation had exceeded targets of 2%. He added all advanced economies were facing "testing times", but he saw no reason why the UK could not cope. However, Mr King also warned there was no quick fix for the current mortgage crisis affecting the economy. (Link to article and Video clip)

Food price rises 'hit UK harder'

The UK is "more exposed" to rising food price rises than its peers, adding to recessionary fears, according to a report by Ernst & Young. Its Item Club says "the implications for business are profound" - making it more likely firms will raise prices. Unlike the US which has a balance of food and France which has a surplus, the UK has a trade deficit in food. The Item Club report says that as food prices keep rising, this reduces the chance of an interest rate cut in the UK. "The danger now is that rising food world prices and energy prices will lead to excessively tight monetary policy", it says, as the government seeks to counter the rise by "squeezing domestic costs". As food and energy prices contribute 1.7% to Consumer Prices Index Inflation - which recently reached 3% - this leaves "little room" for price rises elsewhere. Input costs have risen by nearly a quarter in the 12 months to April, eating into consumers' disposable incomes. Link to article.

The government's 2% inflation target will require a 1.5 percentage-point premium on interest rates because of spiralling food and energy prices. This will lead to sharply lower growth and rising unemployment, as many as 60,000 jobs lost, according to the Item club report, which uses the Treasury model to forecast the economy. It urged the chancellor, Alistair Darling, to exclude food and energy from the inflation target or risk excessive pain for voters in the run-up to the election. Read the Guardian article.

Inflation ...all the fault of the MPC?

According to an article in today's FT, 'the increase in consumer prices index inflation since mid-2007 can be largely explained by rising global prices for food and energy. The deeper question, however, is why these have not been offset by slower rises or falls for other products and services, as would be expected if monetary policy had been correctly calibrated to meet the inflation target.' The MPC ' allowed excessively loose monetary conditions to develop between 2005 and 2007. Bank rate was cut inappropriately in 2005 and maintained below its neutral level until 2007. During this period, investors’ risk appetites significantly increased. The result was a prolonged period of buoyant money and credit expansion.' They discussed rapid money and credit growth in 2006 and 2007 but'played down the dangers'. The upshot is that official neglect of monetary warning signals has once again been followed by 'an unexpectedly large rise in inflation although the details of the transmission mechanism differ. In effect, loose domestic monetary conditions have accommodated or even supplemented the inflationary impact of rising global costs.' It is also suggested that there is liitle scope for further interest rate cuts in the near future. Read the article.

Government 'should change inflation target'

Consumers will be "crucified" unless the government changes its inflation target, a leading economist has warned. Peter Spencer from the influential Ernst & Young Item Club is urging ministers to change the 2% inflation target used by the Bank of England. He warned that interest rates would have to stay at 5% if inflation is to be brought down to 2%. He added that keeping interest rates at their current level would hurt hard-pressed households. Professor Spencer said consumers were paying the price for an inflation target that had become unrealistic given the volatility of oil and food prices. He called for the Bank of England's remit to change so it focused on "core inflation", a measure that excludes food and energy prices and is used in the US. Read details here.

David Smith's piece in the Sundaty Times also makes an interesting read, especially the divergence between base rate and other interest rates in the economy, those that have a real impact on economic activity. Link to article. Geoff Riley provides a summary of the key points on the tutor2u blog. Link

Does the CPI reflect the 'real' level of inflation in the economy?