Inflation is set to dip but any respite won’t last very long
TRADERS betting on the consumer price index (CPI) will have pricked up their ears last week at comments from the Bank of England’s chief economist Spencer Dale. Dale surprised analysts by referring to the “evils of inflation” in an interview with the Independent: “A very senior executive said to me: ‘Aren’t we going back to the bad old days when we just devalued and inflated our way out of trouble?’” he said. “We know the evils of inflation. We have to be incredibly vigilant.”
Dale’s warning came on the back of the release of the minutes of the latest Monetary Policy Committee (MPC) meeting, held on 7-8 July. The minutes showed that, again, the decision to keep interest rates at the extraordinary low of 0.5 per cent was the result of a 7-1 vote, with Andrew Sentance remaining the lone dissenting voice.
This is despite the fact that the minutes showed that the MPC is not likely to hit its inflation target any time soon: “Although CPI inflation had fallen again in June, it was likely to be higher during the remainder of 2010 than envisaged in the May Inflation Report central projection. And the increase in the standard rate of VAT to 20 per cent announced in the Budget was likely to add to inflation, particularly in 2011.”
The MPC continues to be uncertain as to why the CPI is so insistently high, inflation having consistently exceeded its forecasts, especially those made a year or so ago. The Bank predicted a greater likelihood than not that inflation would meet its 2 per cent target by the second quarter of 2010. Instead, the CPI rose to 3.7 per cent in April.
So what does July augur? It largely depends on your view of how much spare capacity there is in the economy. The CPI has eased from its April peak and most analysts expect it to remain around the 3.0-3.2 per cent level with a jump in January as the 2.5 per cent VAT rise kicks in.
Henderson’s Simon Ward expects inflation to cruise downwards for the rest of the year, forecasting a CPI figure of 3 per cent in July: “The headline CPI numbers are probably going to come down over the remainder of the year and that’s mainly because of a base effect. Prices were rising quite rapidly in the second half of last year and as those big rises come out of the comparison the headline rate will fall a bit. But it’ll remain well above the 2 per cent target to finish at around 2.75 per cent by the end of the year.”
Aside from spare capacity, the MPC’s main focus seems to be on inflation expectations – which might help to explain Dale’s hawkish public stance last week. RBS’s Richard Barwell says this worry is overblown, however: “It seems unlikely that there will be a significant upward move in market participants’ inflation expectations any time soon – the market is increasingly concerned about deflation not inflation.” Survey results seem to agree, with a Citi/YouGov poll suggesting that expectations have moved down to 2.7 per cent from 3 per cent last month.
Despite the surprisingly high GDP figure released last week the consensus is that any CPI rises to come are more likely to emerge in the medium-term, with any growth absorbed into the economy’s ample spare capacity for the moment. Then again, the Bank and market analysts have been making similar forecasts for months, and inflation continues to defy expectations. The continuing unpredictability of economic data thus merits a degree of caution on the part of traders.