Things just got a lot worse for inflation

September 23, 2009

David Kuo- David Kuo is director at The Motley Fool. The opinions expressed are his own.-

What is the collective name for a crossing of fingers?

Because that seems to be what the Bank of England’s Monetary Policy Committee members are doing. They are collectively crossing their digits in the hope that they have done enough to steer the UK economy out of recession.

They have pumped billions into the UK economy and it doesn’t seem to be having much effect – yet. That is unless you are a banker looking to bolster your balance sheet with freshly minted notes. Banks are happy to swap their assets for the Bank of England’s cash but remain unwilling to lend. Additionally, there is still uncertaintyabout the ability of the economy to grow unaided if the central bank should stop printing money.

And just when you think that things could not get any worse, it just did. It seems another problem has crawled out of the woodwork is inflation. The Bank believes inflation will be extremely volatile. It may fall in September but near-term inflation may exceed initial forecasts. But because it believes the rise in inflation will be temporary, the suggestion is that interest rates can be maintained at around current record low levels for some time.

However, low interest rates, low growth and low prospects of an economic recovery are spooking foreign investors. Sterling recently sunk to levels not seen for five months against the euro. It has dropped from 1.30 euro a year ago to 1.07 euro, though it has since recovered to 1.11 euro.
UK exporters will undoubtedly welcome the favourable exchange rate against our European trading partners. But the fly in the ointment will be more expensive imports from European.

German cars, French wines, Italian luxury goods, Spanish holidays, Irish butter and Dutch Edam cheese will all cost more.

Inflation is the unspoken effect of Quantitative Easing. It is something we need to guard against if we are to ensure that our nest eggs and investments are not eroded over time. Leaving any money you have in savings accounts may seem like a sensible and safe thing to do now. But over the long term, cash has a terrible record at beating inflation. Consequently, it is better to invest in assets that have a proven track record against rising prices.

If you have a mortgage on a property, now is a good time to pay down as much of the loan you can afford while interest rates are low. If you have money that you can afford to put away for five years or more then it should be invested in shares rather than allowed to idle in a savings account.

Crossing your fingers is not an option. Putting your money to work is because things just got a lot worse.

Comments

David

“German cars, French wines, Italian luxury goods, Spanish holidays”

these are all things we are going to have to live without seeing as they were all bought with excessive credit over ten years. The UK has to start turning around into less of a debtor nation.

I don’t think anyone with a semblance of a taste bud will mourn the rising cost of edam. Now, wheres my colston bassett stilton!

Posted by roym | Report as abusive
 

Inflation is rising and will rise due to the government’s policy of Sterling devaluation. In 2006 the pound bought 40 Czech crowns, today 26! This is why the CPI has not turned negative as predicted. Before Christmas inflation as measured by the CPI will start to rise. The RPI is already rising! What will happen when interest rates have to rise to contain inflation?

Posted by Jeff Gray | Report as abusive
 

Jeff,

We may have to do without a lot of things if a falling pound makes imports more expensive. But where will the possible substitutes come from? What is a viable British alternative for a BMW, a Porche, a Golf or a Mercedes? What about the French wines that many consumers have acquired a taste for?

And what about the high price of Dutch Edam? It’s more than just a case of hard cheese for those who can’t afford it. It’s may mean that many European products could eventually be out of the reach of British shoppers.

David

 
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