Tuesday, January 8, 2008

Inflation vs Interest rate cuts

Blow to rate cut hopes after central banks sound warning over threat from inflation

The world’s leading central banks yesterday emphasised their vigilance against inflation in the face of soaring food and energy costs, dampening market hopes of aggressive interest rate cuts in response to financial upheavals.

Posted by submedia @ 02:18 PM (1388 views)
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5 thoughts on “Inflation vs Interest rate cuts

  • Lets see what the BOE do if the next few months regarding interest rates when faced with clear inflationary pressure.

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  • Its in the housing market stupid… Of course they’ll lower them even if it ends up with currency meltdown.

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  • “Deflation never happens in a fiat currency. Here’s why:

    Deflation is a government’s worst nightmare. People delay consumption because they know prices will be cheaper next week or next year. Jobs are lost, the economy suffers, etc. We always think of deflation as meaning falling prices; however it also entails falling salaries. This means borrowers are more likely to default on their repayments – how can you keep paying the mortgage if your salary is falling? When borrowers can’t pay, that means banks are more likely to collapse. That means a lot of savers lose their deposits. Obviously if one bank collapses, it’s likely to cause a run on other banks. Sooner or later the whole thing collapses. That’s why deflation is so bad.

    Another way of looking at it is to say that fractional reserve banking is bad, and savers should accept a degree of risk when they place their money into anything other than zero-interest current accounts. That goes against people’s natural instincts and wouldn’t float politically.

    Overall it’s far easier for the government to just keep inflating. People keep consuming, buying sofas or cars or houses because they expect them to cost more next year. Rising salaries make people feel better, as do rising asset (house+share) prices. Steady moderate inflation induces a false sense of wealth in everyone. Rigging the inflation figure makes everyone feel better: savers think they are getting good interest, workers think they are getting a good raise, and asset buyers feel confident about their purchases.

    That’s why the government will always choose inflation, and that’s why they are more likely than not to choose the inflationary path out of falling house prices. That’s why gold is rising.”

    This is from Drewster’s earlier post. I post it again here (which I apologize for in advance drewster), because I think it actually has more relevance here than in the post about what will happen with gold. I think it was a very insightful post too!

    Personally I wonder if BoE really can start ignoring inflation. RPI measures are still used at least as a context to the CPI, and that’s not going to change.

    I reckon there are some big differences this time round (in the current and upcoming deflationary cycle) however:

    1. Realtime news – we get economics advisor’s comments at the same time Mervyn King gets them (mostly) so there’s very little bottlenecking of news and statistics on the economy. Everyone can find out the latest inflation stats and their breakdown with a few mouse clicks.
    2. Realtime markets – we don’t have to take our broker out to lunch to move vast sums of money out of the UK and into Japanese bonds (or whatever) – again at a few mouse clicks.
    3. Mistrust of the “great and good”. Newspapers no longer feel it their civic duty to unquestioningly praise economic management of the economy. Likewise consumers no longer feel they can’t be rude enough to tell their bank manager to shove off (in fact some adverts appear to encourage it!)
    4. Freedom of Information Act 2000. Any widespread deception by the BofE or the treasury is on borrowed time – sooner or later the truth will out. Remember criminal offences in government (cash for donations) have been uncovered with this useful little piece of information.
    5. Reflation attempts are inflationary. Last time the government had high inflation and high interest rates. This time they’re trying to get away with having only one.

    These factors combine to make the entire process of fooling all of the people all of the time much more difficult than in the early 1990s.

    This is why, I believe, there will be very little room for the BoE to attempt to reflate the economy.

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  • Thanks Paul,

    IMHO, this is a good analysis. The banks and the Insolvency Practicioners have just made up to wring as much cash as possible from the sheeple (see separate post).

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  • I think derwsters and pauls posts should be stuck permanently on the front page.

    Excellent – cheers guys

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