The monetary screw has been tightened enough to lower inflation
UK policymakers still seem to think that the key to controlling living costs is to depress the economy
‘The danger is that the Bank keeps reaching for the wrong tool – the hammer of ever higher rates’
Another month, another grim set of UK inflation figures. The latest numbers show how difficult it is to bring inflation back down once it has been allowed to run out of control.
The fall in the headline rate in April, from 10.1pc to 8.7pc, was obviously welcome. But it was entirely because of the smaller increases in electricity and gas prices this year than last, which we already knew about.
Other elements of consumer price inflation are much stickier. Food price inflation barely fell at all, bucking the trend in the rest of Europe. The “core” rate (which excludes energy, food, alcohol and tobacco) jumped from 6.2pc to 6.8pc, the highest since March 1992.
This last figure most rattled the financial markets. Investors quickly moved to price in another full point of interest rate hikes from the Bank of England. The official Bank Rate is now expected to be lifted as high as 5.5pc later this year, piling more pain on borrowers and those with mortgages in particular.
It was not all bad news. The latest producer price data showed that pipeline pressures are still easing, including in the food sector. May’s inflation numbers should therefore be better. But the next set of figures will have to improve dramatically to discourage the Bank from raising rates again. In the meantime, the search for someone to blame has intensified. “Greedy” supermarkets are one popular target, even though profit margins in this highly competitive sector are still tiny. In reality, the current high levels of food prices in the shops can easily be explained by past increases in costs, with the usual time lags.
Fingers have also been wagged at those workers who have dared to ask for bigger pay rises to keep pace with the soaring cost of living. Many economists now fear that a wage-price spiral is setting in. The worry is that businesses will try to pass on higher labour costs to their customers, who in turn will demand more pay from their own employers, driving costs up further.
But this diagnosis may be mistaken, too. The larger-than-usual pay increases in some sectors can be seen as catching up with past increases in prices, rather than something that will be repeated. They are also a sign that market forces are doing their job – higher pay is the obvious solution to labour shortages.
Above all, there is a danger of missing the wood for the trees. The Bank of England has admitted that it has got inflation badly wrong, without quite knowing why. A simple explanation is that it has failed to see the bigger picture. For example, many people downplayed the initial rise in inflation because it was concentrated in just a handful of prices, notably energy and food, where there were specific supply shocks. As these shocks faded, “Team Transitory” believed that headline inflation would automatically fall back to target.
And even today, many still say that it makes little sense to use higher interest rates to target inflation “caused by” higher energy and food prices.
The problem, of course, is that this wrongly attributed the rise in overall inflation to whichever prices happened to be rising the most. Instead, as these specific shocks faded, inflation simply popped up somewhere else.
An alternative explanation is that the surge in inflation is something to do with the rapid expansion of the money supply. If so, this is actually reassuring, because monetary and financial conditions are now much tighter. This means that inflation should still fall sharply over the remainder of the year, without the need for further increases in interest rates.
Unfortunately, however, the Bank of England may have boxed itself into a corner. A majority of the nine members of the Monetary Policy Committee (MPC) still seem to believe that the key to getting inflation down is to keep depressing economic activity. Equally unfortunately, monetary tightening is like slowly boiling a frog. By the time you realise you have done too much, it may be too late.
The Government has created a problem for itself, too. When inflation was above 10pc, Rishi Sunak set a target of halving it by the end of the year, but with no clear idea of what the ministers are supposed to do to achieve this.
There is little political upside here. If inflation does fall below 5pc, as is still likely, it will be hard for the Government to claim credit for something that would probably have happened anyway. On the other hand, if inflation remains stubbornly high, it will be impossible to dodge the blame.
The Prime Minister could point to his warnings last year that the bolder policies advocated by Liz Truss might lead to financial instability and even higher inflation. However, Sunak has now been in No10 for seven months, inflation is still high, and so are interest rates – including the cost of government borrowing.
We will all be paying the price for this. The search for someone to blame and calls for “something to be done” are a recipe for trouble. Unfair accusations of corporate “greedflation” have already led to calls for more “price controls”, despite history teaching us they will almost invariably backfire.
Demonising workers is unhelpful, especially those on the lowest incomes. Are we really saying that people on benefits, or the national minimum wage, should bear the biggest burden in the fight against price rises?
Inflation is a sickness. It erodes the money in our pockets, sparks industrial action and encourages the villainisation of particular industries or workers.
It may give politicians sleepless nights, but it is the Bank of England’s job to worry about inflation. The MPC has the right kit to get inflation back down, even if it delayed deploying it for far too long. The danger now is that it keeps reaching for the wrong tool – the hammer of ever higher interest rates – when the monetary screw has already been tightened enough.