Wednesday, February 17, 2010

Inflation Numbers

This week the Governor of the Bank of England had to write to the Chancellor as Inflation surpassed the 2.0% target. The actual Inflation number given was 3.5% however this is the CPI (Consumer Price Index) number, which is the index that does not take into account the cost of housing. The CPI number thus does not take into account what most of us would consider our most important and usually highest outgoing each month. The CPI measurement is the measure set by Gordon Brown when he became Chancellor for use when setting monetary policy.

The RPI (Retail Price Index) number does take into account housing, and is still used for the setting of benefits levels, public sector pay and index-linked government debt. This number was actually 3.7% and so is higher than the CPI number and is generally more reliable for us non-economists in measuring inflation against our changes in cost of living.

The banks however are a little more sophisticated and use their own measure or RPI which excludes interest charges (RPIX). RPI alone can distort because it reflects swings in mortgage rates, and at the moment rates are being kept low by the Bank of England. The RPIX number currently stands at 4.6%, and you won't need a calculator to see that is a full 1.1% above the official CPI number.

Inflation going up was the expected side effect of the recent Quantitative Easing programme, the fear was always that Inflation may reach a level that becomes difficult to control. I speak to the effect to us people on the street as we will feel this in increased prices in the shops and in our bills. The problem is that Labour and quite likely the Conservatives are making noises about a 20% VAT rate after the General Election. This of course relates to you and me as an additional rise of the price in the shops.

To me, I think the way forward is to help people hold on to more of their hard earned money, typically this will be used to either pay down personal debt or passed on in the form of spending. Both of these actions are good, personal debt is worryingly high and consumer spending is very low and this is fuelling this slowdown. With Interest Rates low, there may not be the inclination to put the money in the bank which at this time would not really help too much. However, the danger I see is if inflation takes hold, the Bank of England may see the need to start raising interest rates, which will in turn raise the cost of variable mortgages and make borrowing tougher which in turn will leave many people with less money and in turn stifle consumer spending which is already in the doldrums.

The Governments car scrappage scheme seems to not be a greatly inspired economic scheme. Yes, there were some tax payments, but there was also a large subsidy. However, the bulk of the cash spent on the cars then made it's way off shore back to the car producing nations that have exported to us. No wonder France and Germany came out of recession months before we did. What we also need, as I repeat over and over again is to export as much as possible to places like China where they are sitting on Billions of Dollars. Bring cash into the country, and let it circulate a bit to stimulate spending. When people are spending shops and domestic manufacturers start hiring.

With my usual caution about the lack of my economic credentials I submit this as my working theory as to why we should cut taxes now to reap as much of a benefit from the QE programme as possible.

4 comments:

Mark Wadsworth said...

The priorities must be reducing public sector spending, ending Home-Owner-Ist economic policies and getting out of the EU.

Letters From A Tory said...

Agree with Mark, although I can't really see an incoming Conservative government picking a fight with the EU anytime soon - if ever.

TBJ said...

I worry about inflation. My concern is that we havent seen the end of this, and we wont for a long time. QE was always going to inflate the currencies, however most of the major currencies have gone through this process so i assume it would be considered to be mass devaluation of all currencies effectivly. I doubt thats how it will work out. So, Intrest rates go up, which ofc the consumer will bear the brunt of after seeing none of the benefit of low interest rates recently. Life sucks?

p.s. totally disagree with the EU comment there lads, but yer deffo agree on the PS spending; ofc how they go about that is the question isnt it :P

James Higham said...

3rd quarter will be lots of fun here.