Inflation above 5% before interest rates below 5%?
It was only in June 2008 that the governor of the Bank of England had to write his grovelling letter to the chancellor explaining why UK inflation was above 3 per cent when the target is 2 per cent. But inflation is galloping ahead so quickly that July’s figure will already be over 4 per cent - and it is heading quickly towards 5 per cent.
The July inflation figure will be published on 12 August, the day before the Bank publishes its quarterly inflation report. Expect the Bank to be realistically gloomy.
The fall in the oil price from its peak is a sign that recession is doing its job in reducing demand but inflation will stay in the system for a long time.
If the UK consumer prices index climbed in July at the same rate it has done for the rest of 2008 then the inflation rate would be 5 per cent already. However, there tends to be a fall in the prices index (though not the inflation rate) during August as seasonal foods become available.
Will that happen this year? Food prices are one of the big drivers of the current inflation and there is a great danger that instead of falling they merely slow their relentless rise and that the index keeps increasing during July. On that basis, 5 per cent inflation is looming.
If the Bank of England now thinks recession so imminent that it either can or must reduce interest rates from their current 5 per cent base, then we have the prospect of prices rising faster than the return on cash – an incentive to spend because money will go less far in future.
That in itself will help reflate the economy, but it really should pay to save and an inflation rate higher than interest rates makes that impossible.
