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.

Comments

i entirely agree with Mr Campbell’s analysis of the financial situation

I live in france and many of my expat friends have been saying how cheap Briton has become following the reduction in the value of the pound. I have however constantly reminded them that as a country that imports some 70% of its goods etc It is inevitable that there will be a financial adjustment, either through the medium of inflation, wage reductions in real terms, or a revaluation of the pound upwards in time, or perhaps a combination of all three.

Drastic corrective action has to be taken to correct the countries finances,no doubt after the election, the bank of England have been far too complacent about inflation, no doubt to avoid upsetting their political masters. I am certain that interest rates will rise this year as will inflation in the next 6 months

The currency value has a great effect on the expat finances and we look forward to a governmant that will run the country with nonesty and integrity and get britons as a whole to live within their means. If I sound like a Bank Manager, I was one once!!

Posted by Richard Thomas | Report as abusive
 

Personally, I suspect that the target of 2.0% is merely there to keep a lid on people’s inflation expections.

I’d like to see some evidence that the BOE are targetting a range of say 1.5% to 2.5% (as would be expected with a target of 2.0%). But from everything I read, anything below 2.0% is regarded as “risking deflation” while inflation well above 3.0% appears to be perfectly acceptable (provided that it’s only due to short-term effects – which it always is).

There’s almost certainly political pressure to keep inflation high and interest payments low in order to assist the Government with paying its debts.

As someone who never borrows money to fund a purchase, I find the BOE’s refusal to tackle inflation (or to offer savers a moderate rate of interest) to be really frustrating.

Also as a Software Engineer, my salary hasn’t kept up with inflation for years. Perhaps if I’d gone into banking instead, I could have reaped the benefits of this inflationary expansion.

Posted by Daniel | Report as abusive
 

UK inflation is not caused by high oil prices, it’s caused by higher supplies of money and credit within the UK. If UK money supply was stable, and only oil prices went up, then the price of some other good would have to fall.

Inflation itself does not erode debt. Only real increases in wages, leading to greater net disposable income can help reduce debt. However wages have continually lagged inflation rates (money supply) and even if we do get high wage growth, interest rates will rise even faster, compounding the debt.

Finally, allowing banks to borrow at 0.5% and charge 4% to the public only helps the bankers (who were already bailed out by the public). There is no evidence that inflation has ever helped anyone but governments and bankers at the expense of everyone else.

Posted by paul | Report as abusive
 

I totally agree that allowing banks to borrow at 0.5% and charge 4% to the public is utterly scandalous. It’s no wonder that they’ve had record bonus payouts again.

Posted by ActionDan | Report as abusive
 
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