18.02.10 by Rob Gill
Higher Inflation and Interest Rates the Future for the UK?
As the CPI measure of inflation reached 3.5% in January, well above the official 2% target and the 3% limit at which the governor of the Bank of England has to write to the Chancellor, economists are starting to question whether this is just the temporary “blip” Mervyn King is insisting. Not only might inflation prove stickier in the short term than Mr. King expects, in the medium to long term economists are wondering whether permanently higher inflation and interest rates are the future for the UK.
The Governor’s argument is that this surge in inflation is due to the return of VAT to 17.5% and rising commodity prices, that their effects will eventually drop out of the inflation figures and are therefore temporary. With both major parties however considering a further, post election increase in VAT to shore up the UKs beleaguered public finances, there’s every chance that such a “blip” could be repeated in the summer.
Rising commodity prices meanwhile are very much a function of the recovering global economy, so this “blip” could well occur again too. Higher UK taxes to bring our public debt back within normal boundaries and rising commodity prices in response to improving global demand are underlying trends with firm fundamental reasons. As such they are likely to be reflected in UK inflation figures more than once.
In the longer term, economists are starting to question whether a 2% inflation target is realistic or desirable. Although not without consequences, a good bout of inflation is the cheapest and easiest way to erode debt and would certainly be a help to the UK on both a public and private level. Indeed, David “Danny” Blanchflower, a recent former member of the Bank of England’s rate setting committee, has remarked that a target of 4% would be more realistic and desirable..
Longer term, a higher UK inflation target would also permit higher interest rates, which would then leave more slack in times of crises for them to be cut. This theory rests on the concept of “real” interest rates, which simplistically speaking are the difference between actual interest rates and inflation. In recent, more normal, times for example base rate has been around 6% and inflation 2%, thus the real interest rate has been 4%. If inflation were allowed to rise to 4%, the same real interest rate would lead to an actual base rate of 8%. This means that in times of crises, base rate could be cut further and with more effect, making monetary policy a sharper, more effective tool.
This slightly complicated theory is starting to gather more credence as the inflation and interest debate rumble on. Given how inflation helps erode debt, the UK public debt position could also make a rise in our inflation target very convenient politically. It is certainly one worth watching from a mortgage point of view due to the effect it would have on base rate, and as property prices tend to be inflation linked it also has implications for home owners on this front too.
Rob Gill
Director Private Clients
Monty’s Mortgage Blog
19.08.10
Mortgage Lending Up...A Bit
Today saw the release of the latest set of data from the Council Of Mortgage Lenders, (CML) stating that Gross Mortgage Lending rose by 5% in July compared to June, although this is still 3% down from July 2009.
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