Hard Task

17/09/2010 at 10:31 am 4 comments

Spare a thought this week for Mervyn King. For the eighth month in a row, CPI inflation has come in at 1% or more above the 2% target set for him by the Chancellor. The Bank of England has been saying for some time that high inflation was due to temporary effects such as this year’s VAT hike or the recent weakness in sterling, and the City believed them, with headline and core CPI both forecast to fall.

However, the release of data for August on Tuesday saw the headline number stuck at 3.1%, and the core rate – which excludes the supposed distraction of more volatile items such as food and fuel – actually rise (to 2.8%).

But it is not only the level of inflation which should be giving the Governor a headache.

On Wednesday, UK earnings data showed that after a promising first half of the year, wage growth has practically stalled with average earnings for the last three months only 1.5% higher than the equivalent period last year. Adjust this for the previous day’s inflation number and we find that the purchasing power of the average employee’s pay packet will have fallen by some 1.6% during that time.

Britain’s relatively high inflation makes this a unique problem. On the latest figures, real wages are flat on the year in the Eurozone, 0.6% higher in the US and up 2.2% in Japan. So for most of our competitors, the end of recession has signalled a gradual return to increased prosperity, while British workers have got poorer.

This state of affairs has attracted relatively little comment so far, but if it persists, a prolonged period of falling real wages would undoubtedly dent consumer confidence and spending and possibly single the UK out for the rollercoaster ride of a “double dip”.

We hope that inflation falls away as the Bank expects and forecasts it to. After all, broad money growth is near zero, sterling has been getting stronger for six months and the economy is growing but slowly. So perhaps the recent data reflect little more than temporary pricing quirks – retailers who absorbed the cost of January’s VAT hike at first but have now decided not to do so, for example.

But if there is something uniquely inflationary about the UK – something in our supply chain that is causing sustained upward pressure on prices – the impoverishment of workers (and pensioners, and savers) will become ever more meaningful and the Bank will have to increase rates to kill inflation off. This is after all the whole point of having an inflation target to begin with. And in that case the nascent recovery could be choked off.

On the one hand, a policy decision that could kill the British recovery; on the other, inaction that could see recovery destroyed by the erosion of real incomes. Not an enviable choice.

Poor Mr King.

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4 Comments

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