So inflation remains at 4.5% (or 5.2% if you take retain price inflation), more than double the 2% target that the government is supposed to work to. Without drops in transport costs the figures would have been even worse. And this is happening when there is lots of spare capacity in the economy, which is supposed to hold inflation down. So what is going wrong?
Firstly there is the £200 billion of quantitative easing (QE). Printing this much extra money dilutes the money that is already out there making it less valuable, so inflation is inevitable. Then there are the higher commodity costs as global demand increases with the way the developing world is catching up with us. Don’t expect the Chinese to give up their cars any time soon. And of course there is the low value of the pound which makes our vast level of imports more expensive.
And of course inflation could get a lot worse, as we have seen in the past. Our economy is growing and will soon use up that spare capacity and commodity prices look to stay expensive. If people start generally getting pay increases to compensate for the inflation we could very quickly end up in an inflationary spiral.
The answer, naturally, is higher interest rates. But this would hit the housing market. People with mortgages have been having it very easy for the past few years and a return to normal interest rates would be a shock to many. Though some may say this is a good thing as we still have a housing bubble that needs correcting.
An interest rate increase would make the pound stronger making imports cheaper and exports more expensive, this may help reduce inflation but it doesn’t help our trade gap and the big numbers of workers employed in export industries. So it is a fine balancing act.
Then there are the many people leaving the public sector (not enough). They will help keep wage inflation down by increasing the supply of labour. If they are capable of doing real world jobs.
And finally there is the thought that the government might actually like a fairly high level of inflation for a while. It effectively erodes the value of our immense national debt, meaning we pay back far less in real terms. And it brings down the value of inflated assets, like houses, without it being too obvious to the owner of those assets.
So it is easy to see why the majority of the MPC (Monetary Policy Committee of the Bank of England) continue to vote to keep interest rates down. But at the same time they really are playing with fire.