Uk Rate Rise Is Common Sense - Telegraph

[Tenubracon]

http://www.telegraph.co.uk/finance/comment/liamhalligan/8320340/UK-rate-rise-is-common-sense-whatever-the-inflation-deniers-say.html

In May 2009, the Bank forecast that CPI inflation, then 2.9pc, would fall to 0.7pc during the second quarter of 2010. The outturn was 3.5pc. One astonishing forecasting error could be seen as unfortunate. Two in a row and even reasonable people might think the Bank is wilfully ignoring future price pressures.

That’s where we’re heading. In August 2010, the Bank said CPI inflation would fall to 2.8pc in the second quarter of 2011, reaching 2.2pc by the end of this year. This coming Tuesday, we may learn that inflation in January topped 4pc. Based on recent trends, a 5pc CPI number in the coming months isn’t unlikely.

The Bank won’t be able to blame the high January number on last month’s VAT rise, seeing as the impact of that was already part of its August 2010 forecast. It will likely point, instead, to high oil prices.

But it has long been obvious that commodity markets would stay firm in the face of rising demand from the Eastern emerging giants. At the very least, such an outcome was a genuine possibility.

The Bank’s claim that above-target inflation is “temporary” has been blown out of the water. As a result, UK monetary policy has a serious credibility problem. That matters – a lot. For several years now, the Monetary Policy Committee has collectively argued that economic weakness pointed to an absence of inflationary pressures.

This view, while comforting for the UK’s hugely indebted government, was spectacularly wrong. So unless the Bank takes steps to rebuild its credibility, expectations of future inflation will be self-fulfilling.

Yet still the Bank and its courtiers maintain their position “without a shadow of doubt”, turning their faces against the torrent of evidence which makes a nonsense of their view. Last month, the respected CIPS producer input price index hit 84.9 – a record high. Meanwhile, producer output inflation soared to 4.8pc, highlighting serious future price pressures.

Producers are facing higher costs but the inexorable fact – as anyone who does their own shopping will tell you – is that such costs are being absorbed by wholesalers and consumers. This has been clear for some time now and very strongly suggests medium-term inflation won’t slow nearly as much as the Bank insists.

The CPI is, anyway, a deeply flawed index. The Bank used to target the more accurate RPIX – before Gordon Brown, in yet another example of his statistical dishonesty, moved the goalposts in 2003. RPIX inflation is now 4.8pc – almost double its previous 2.5pc target, having averaged that level for over a year.

With the CPI stubbornly above target, the inflation-deniers have tried focusing attention on so-called “core” inflation – a measure excluding food and fuel. This may be useful in a country where no-one drives or eats. In Britain, it amounts to nothing more than “statistical spin”.

Even the UK’s core inflation index is now flashing red, reaching 2.9pc in December, a six-month high. So if you ignore the recent commodity price spike, CPI inflation was still way above target at the end of last year. That was at a time when, as we recently learnt, the UK economy was contracting. Despite these stark realities, the majority of MPC members, paid by the public purse, are still telling us that inflation isn’t a problem.

With “core” measures giving awkward readings, the deniers have lately reached for an even more obscure inflation index – CPIY. That registered 2pc in December, but excludes indirect taxes. Given that, CPIY hugely understates genuine inflation as it assumes such taxes are fully passed-on to consumers. The Government’s own research indicates actual tax pass-on is much lower and, had tax rates remained stable, inflation would still be around 3pc.

Perhaps the most disturbing aspect of the MPC’s analytical failure has been its reliance on the so-called “output gap”.

Under this mode of thinking, we are invited to believe the UK can massively expand the base money supply, and the Government can keep borrowing like crazy, with no fear of inflation whatsoever – because the UK’s enormous “spare capacity” can soak up extra demand without driving up prices.

For several years, now, this column has referred to the output gap as an “intellectual conceit”. Given the ferocity of the credit crunch, the UK has lost enormous productive capacity, as firms have closed, workforces have dispersed and some companies, in a desperate bid to survive, have been forced to flog their capital goods to overseas buyers. And while unemployment in the UK is quite high, a large rump of our jobless are, given their lack of skills, sadly unemployable.

The inflation numbers we’ve been seeing mean that much of the economics profession is now starting to agree with this view.

Even within the Bank itself, Dr Andrew Sentance, who until recently has stood bravely alone on the MPC in calling for a rate rise, dubs output gap analysis a “narrow way of thinking”.

Last week Professor Tim Besley, a former MPC member, said he was also “very sympathetic to the view there has been a very big supply shock” in the UK.

The reality is that for all the policy elite’s pomposity and statistical hocus-pocus, investors have become worried about UK inflation.

Having believed at the start of 2011 that there was little chance of a rate rise this year, the markets are now betting heavily that the Bank will simply have to act by May.

Tolstoy’s words above come from The Kingdom of God is Within You – his non-fiction magnum opus. This is an exploration of truth, not least within the realms of public policy. As such, Tolstoy’s quotation offers us an early explanation of so-called “confirmation bias”, the tendency of powerful people to favour evidence that backs up the version of events they need to be true, even when such evidence ultimately disproves their views.

Advocates of a UK rate rise aren’t “inflation nutters”. We believe, instead, that action is required now, before the markets force the issue, to prevent higher inflationary expectations worsening Britain’s output-inflation trade-off, thereby seriously harming future growth. As it happens, common sense and decades of policy evidence are on our side. But that won’t stop legions of otherwise intelligent and prominent people from dismissing us as “mad”.

• Liam Halligan is chief economist at Prosperity Capital Management

[billybong]

As a result, UK monetary policy has a serious credibility problem.

Yes indeed. The serious problem is that they have no credibility.

In dealing with inflation they are no better than the politicians that they replaced.

In fact they are worse because as well as being incompetent in meeting the target they try to pretend that they are principled and independent.

Not only that but they are totally self serving and greedy with their policies as their own pensions and wages are inflation proofed.

Edited February 12, 2011 by billybong

[billybong]

Last week, the Bank once again refused to raise interest rates. The base rate remains at its record 0.5pc low – where it’s been for almost two years. Yet December CPI inflation, at 3.7pc, was way above the official 2pc target.

This is nothing new. CPI growth has exceeded 2pc for 31 of the past 36 months. For no fewer than 20 of those months, it has been above 3pc – requiring the Bank Governor, Mervyn King, to write an explanatory letter to the Chancellor.

Going back 5 years it has exceeded its 2% target for about 54 months out of the last 60 months.

Edited February 12, 2011 by billybong

[OnlyMe]

Yes indeed. The serious problem is that they have no credibility.

In dealing with inflation they are no matter than the politians that they replaced.

In fact they are worse because as well as being incompetent in meeting the target they try to pretend that they are principled and independent.

Not only that but they are totally self serving and greedy with their policies as their own pensions and wages are inflation proofed.

An act of market abuse / rigging and fraud. Who gets to determine the supply of TIPS and who they are sold to as well?

[tpbeta]

How hard is it to get? If interest rates go up to nomal, there will be a massive house price crash followed by a recession that will make the 1980's look a like a walk in the park. If they don't there will be some inflation.

So interest rates will not go up by very much, if at all.

[singlemalt]

The BOE are likely to raise rates once there's widespread demands for pay rises. The clammer has been placated due to job security fears. At present Joe Public are tolerating inflation because many are benefitting from low mortgage rates. There's more danger to the economy from borrower default so savers get largely ignored.

If the bonds market starts to turn against the UK then that could be a different story altogether.

Edited February 12, 2011 by singlemalt

[gf3]

How hard is it to get? If interest rates go up to nomal, there will be a massive house price crash followed by a recession that will make the 1980's look a like a walk in the park. If they don't there will be some inflation.

So interest rates will not go up by very much, if at all.

Yes I think your right the BofE are doing the right thing as far as I'm concerned. I keep hearing people saying about inflation this isn't inflation this is the sound of us getting poorer. Hiking interest rates isn't going to stop us getting poorer. Having competitive industries is. Britain is going to have to start earning a living pushing a few numbers up or down isn't going to cut it any more.

[Realistbear]

I am afraid I am with the Muppets. An IR will precipitate a massive HPC and they must do all they can to be seen to be preventing that which must happen. If I was a muppet I would say the house market is the key to our survival and must be preserved at ANY cost--even inflation and the destruction of savings and the rest of the economy. If house prices level off then, and only then will they DARE to stick their toe in the IR hiking pond.

Its ALL about houses--UK Plc is driven by them.

Edited February 12, 2011 by Realistbear

[SNACR]

Yes I think your right the BofE are doing the right thing as far as I'm concerned. I keep hearing people saying about inflation this isn't inflation this is the sound of us getting poorer. Hiking interest rates isn't going to stop us getting poorer. Having competitive industries is. Britain is going to have to start earning a living pushing a few numbers up or down isn't going to cut it any more.

Except we're a country running a huge deficit and reliant on incessant borrowing to fund our bloated state.

At some point investors might decide there's better deals for their money out there. At which point the BoE meeting will be only for show as we'll no longer really have the ability to dictate rates ourselves.

[Realistbear]

Except we're a country running a huge deficit and reliant on incessant borrowing to fund our bloated state.

At some point investors might decide there's better deals for their money out there. At which point the BoE meeting will be only for show as we'll no longer really have the ability to dictate rates ourselves.

If there is a run on the £ then they must hike the rates.

As of now, £ is everyone's favourite as the Elephant is still invisible all the time we appear to be doing well.

The Muppets would like to see £ depreciate by around 10% from where it is now and Merv is probably engineering that by remaining vigilant.

[SNACR]

I am afraid I am with the Muppets. An IR will precipitate a massive HPC and they must do all they can to be seen to be preventing that which must happen. If I was a muppet I would say the house market is the key to our survival and must be preserved at ANY cost--even inflation and the destruction of savings and the rest of the economy. If house prices level off then, and only then will they DARE to stick their toe in the IR hiking pond.

Its ALL about houses--UK Plc is driven by them.

Massive deflation in manufactured goods has left a generation of complacent central bankers and politicians unable to comprehend the difficulty in stuffing the inflation genie back in the lamp.

[LJAR]

Yes I think your right the BofE are doing the right thing as far as I'm concerned. I keep hearing people saying about inflation this isn't inflation this is the sound of us getting poorer. Hiking interest rates isn't going to stop us getting poorer. Having competitive industries is. Britain is going to have to start earning a living pushing a few numbers up or down isn't going to cut it any more.

I agree with the first part except to add "yet".

If we start getting wage price spirals then this WILL be inflation, and if the banks start lending like the govt wants them too then again we will have an inflationary spiral.

Hiking interest rates would stop people trying to use bricks and mortar as an "investment" it isn't. We need them to put their money into companies in order to fuel some productive investment, higher interest rates would help that process.

[Fairies Wear Boots]

How hard is it to get? If interest rates go up to nomal, there will be a massive house price crash followed by a recession that will make the 1980's look a like a walk in the park. If they don't there will be some inflation.

So interest rates will not go up by very much, if at all.

Whilst I agree with the first bit, the second bit is not at all guaranteed. The last time interest rates shot up and there was a HPC they still kept on rising the interest rates.

"If they don't there will be some inflation." You said that like there will be no ill consequences of this. If our pound starts dropping, and then dropping some more, they will have to defend the currency or oil, food and all the stuff we buy from overseas starts becoming prohibitively expensive.

It also looks like theyh are going to keep rates low until they are forced to rise them. That'll be fun!

[gf3]

Whilst I agree with the first bit, the second bit is not at all guaranteed. The last time interest rates shot up and there was a HPC they still kept on rising the interest rates.

"If they don't there will be some inflation." You said that like there will be no ill consequences of this. If our pound starts dropping, and then dropping some more, they will have to defend the currency or oil, food and all the stuff we buy from overseas starts becoming prohibitively expensive.

It also looks like theyh are going to keep rates low until they are forced to rise them. That'll be fun!

The only difference between your view and mine is you think there's a way out

[HPC001]

Nice of them to write off the unemployed and the opportunities to restart business here in the same paragraph.

[dubsie]

And what would a rate rise do, it certainly won't halt inflation. To understand how to control inflation you need to look at the causes:

1. Rising stealth taxes

2. Rising cost of food

3. Rising cost of commodities, copper, gold etc

4. Rising oil prices

Interest rate rise won't control the above because most of it is rising due to global pressures.

It would a different story if the UK economy had rapid

growth a wage growth....clearly not the case.

[Bruce Banner]

And what would a rate rise do.....

It would be a start at sorting out the mess left behind by Labour.

[dubsie]

It would be a start at sorting out the mess left behind by Labour.

it might cause a housing cras but it won't halt inflation, sort of defeats the object.

Housing crash is no good for anyone, another crash now would leave the uk in ruins.

[Bruce Banner]

it might cause a housing cras but it won't halt inflation, sort of defeats the object.

Housing crash is no good for anyone, another crash now would leave the uk in ruins.

No more boom and bust .

[SNACR]

And what would a rate rise do, it certainly won't halt inflation. To understand how to control inflation you need to look at the causes:

1. Rising stealth taxes

2. Rising cost of food

3. Rising cost of commodities, copper, gold etc

4. Rising oil prices

Interest rate rise won't control the above because most of it is rising due to global pressures.

It would a different story if the UK economy had rapid

growth a wage growth....clearly not the case.

The cause is the expansion of the money supply at a rate faster than the true underlying productive economic growth.

An interest rate rise would begin to contract the supply and, despite various factors eroding its potency as an economic tool, it would inhibit inflation.

[gf3]

The cause is the expansion of the money supply at a rate faster than the true underlying productive economic growth.

An interest rate rise would begin to contract the supply and, despite various factors eroding its potency as an economic tool, it would inhibit inflation.

But money credit expansion has stopped and is already in reverse.

isn't it?

[Fairies Wear Boots]

The only difference between your view and mine is you think there's a way out

I don't think there is a way out. Leave interest rates where they are, currency crisis. Raise them repo's, the over extended can't buy much. Our banks are in trouble.

And what would a rate rise do, it certainly won't halt inflation. To understand how to control inflation you need to look at the causes:

1. Rising stealth taxes

2. Rising cost of food

3. Rising cost of commodities, copper, gold etc

4. Rising oil prices

Interest rate rise won't control the above because most of it is rising due to global pressures.

It would a different story if the UK economy had rapid

growth a wage growth....clearly not the case.

Raising interest rates will do some good. 2, 3 and 4 all come from overseas. If raising interest rates shores up the pound then these will cost less or at least won't increase at the same rate. Anyway, I was mainly saying that we'll have to raise rates so our pound is still worth something. The base rate being where it is and inflation being at 4 percent, shows they don't really want fight inflation. I'm saying at some point they're going to have to.

Also as for no wage growth, that can change. How long until the unions start demanding pay rises of at least the rate of inflation? Wasn't there an article posting on here that private sector wage rises have been picking up pace?

[SNACR]

But money credit expansion has stopped and is already in reverse.

isn't it?

IR rises will encourage borrowers to divert spare cash into paying off loans early.

[Fairies Wear Boots]

But money credit expansion has stopped and is already in reverse.

isn't it?

Hang on a minute, isn't interest rate rises the broad tool they use to control inflation? Yes in freak times it doesn't work, like when the financial crisis hit and they dropped the base rate yet we still had inflation falling. But now inflation is ripping along nicely. And we still have the base rate at 0.5 percent.

[gf3]

IR rises will encourage borrowers to divert spare cash into paying off loans early.

Bit of a double edged sword there. Yes I would pay off a large chunk of my mortgage if my mortgage interest went above my savings interest rate.

however as mortgage rates go up a bigger proportion of the mortgage payment is interest so the capital repayments each month goes down.