Inflation impoverishes Britons the easy way

April 21, 2010

– The author is a Reuters Breakingviews columnist. The opinions expressed are his own –
campbell
Critics might say the UK’s inflation target is just for fun. Consumer prices were 3.4 percent higher in March than in the previous year, well above the 2 percent target rate, but the Bank of England will do nothing at all.

If the central bank were serious, shouldn’t it raise interest rates and crush every bit of life out of the UK economy? Not really. The UK has above target inflation because world oil prices are high, the pound is low and VAT is up. But it has inflation for poorer and richer.

Poorer because UK prices are pushing up while most incomes aren’t and interest income is not keeping up with prices. Rebalancing was what the economist doctors ordered and this is how it comes, in nasty monthly pills that show prices have gone up more than pay packets.

The UK wants growth but needs to tighten its belt. It has a big trade deficit which will fall when Britons export more and consume less. It has a big fiscal deficit which the government needs to cut. Draconian cuts to public wages, Irish style, wouldn’t be politically acceptable, while a bit of inflation is an easy way to erode wages, pensions and debt.

But inflation has its richer side too. It can help the UK economy to grow because 3.4 percent inflation makes the Bank of England’s 0.5 percent bank rate a bargain. Banks can take a wide margin on 3 percent mortgages. Lending at below the inflation rate is a big incentive to borrowers — one the Irish, Greeks and Spanish used to enjoy enormously and that Britons didn’t even need. They need it now.

And so the BoE can be relieved the UK has inflation rather than deflation. But much bad news lies in wait. The next government, whichever it is, will do some of its rebalancing the hard way, with spending and job cuts and tax increases which will tend to chop growth away for a while. The BoE is probably right to think highish inflation will go away, too.

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