Renthusiast2.0

The UK’s Consumer Price Index (CPI) rose to 3 per cent in December, up from 2.7 per cent in November and was the highest on record according to the National Statistics office. The Retail Price Index (RPI) also rose to 4.4 per cent in December, the highest since 1991. The two indices are used by government statisticians and economists as measures for inflation (or deflation) rates in the overall economy.
Rising mortgage costs had an “upward effect” on the RPI in December, mainly due to increasing interest payments; with lenders passing on the November 2006 quarter point increase in the Bank rate.
The BoE used the 2.7% CPI November figure as justification for their “shock’ rate rise last week. At 3% we should assume/prepare for another rate rise next month. This weekend, in the Sunday Times, economics editor David Smith wrote:

I dont want to scare anybody unduly, but the last time we had a retail price inflation beginning with a four … the bank lifted rates to 7.5%. Yes 7.5% …

In a speech today, Dr Andrew Sentance of the Bank of England described inflation in simple terms as: “too much money chasing too few goods”. Dr Sentance explained that in order to understand whether there is too much money, “we also need to understand the factors affecting the production of goods and services, and how changes in these supply factors are affecting the outlook for economic growth and inflation.”
Dr Sentance highlighted labour as one such “supply factor” affecting the economy and concluded that normal labour supply growth would add 0.3- 0.4% a year to the country’s GDP. However, minimum wage increased to £5.35 an hour last October, up from £3.70/hr in 2001 representing a 45% increase; more than four times the consumer prices index increase and more than double the rate of growth of average earnings for the same period. Sentance feels that this dramatic wage increase could have a “negative impact on employment prospects and add to wage pressures in some sectors of the economy, exerting some upward pressure on the level of structural unemployment.”

The chart above shows unemployment rising in the UK, which Sentance describes as “something of a puzzle”, citing “supply shocks” from increasing migration and increased participation of older workers as one probable explanation:

According to official estimates, net migration into the UK has risen fourfold since the mid-1990s, from around 50,000 a year to around 200,000 a year in 2004 and 2005. These figures have been boosted in particular by higher migration from the eight new members which joined the European Union in 2004, though the official figures suggest higher net migration goes back to the late 1990s. If sustained, this pattern of migration could contribute an addition of up to half a percentage point per annum to the growth of labour supply and hence employment. …
On the other hand, the recent surge in migration associated with the accession of new members to the European Union may ease off over the years ahead. Though the accession process is continuing, with Romania and Bulgaria joining this year, more EU countries are now opening their borders to migrant workers – providing alternative employment opportunities.

Indeed, today’s inflation report highlighted UK growth at a rate above the EU, citing the provisional inflation rate for the EU 25 in November at 2.1 per cent, compared with the UK rate of 2.7 per cent. The lower inflation will no doubt have an effect on cost of living which could be a great incentive for new EU members to migrate elsewhere. For example, Germany’s booming economy, coupled with low inflation and a diminishing labour market, in the short to medium term have greater pull than the UK’s over-inflating economy.
Dr Sentance concluded his speech by reminding us that the background to latest rate rise was primarily the rise in CPI. With December figures …

“significantly above its target level … if inflation is to be brought back to target and remain there, demand needs to be appropriately restrained and expectations of inflation by wage and price-setters must remain consistent with the 2% CPI target. As the press release accompanying last week’s interest rate move made clear, the MPC judged a further interest rate rise was needed to ensure that these conditions would be met and keep inflation on track to meet the target over the medium term.

Conclusion; brace yourself and hold your noses, expect another rate rise next month.