The Inflation Question
April 23, 2007 at 3:59 pm | In bank of england, economy, gordon brown, interest rate | 2 CommentsLast week, the Bank of England announced record inflation rates prompting Mervin King, the central bank’s governor to write a letter to UK chancellor Gordon Brown, explaining why consumer inflation had reached a level that was more that 1 percent higher than the recommended 2% inflation rate.
The letter did not explain why the 2% rate was chosen as safe inflation, since inflation at any rate is , well, still inflation. The question: why at 2% inflation is “good”, but at 3% inflation is “bad” intrigued my mind. I couldn’t get any answers in the FT, Wall Street Journal, or any other financial broadsheet, so I decided to do further investigation into the inflation question to see if I could come across some explanation, forcing me to re-read “The Force of Finance”
Krugman’s occasional recommendation of 2 percent inflation means that money would loose half its value within 35 years – one generation. Why is that good?
asks Brenner
Indeed, in some of his writings for Slate magazine and others, Krugman appears to admit that inflation targeting as a solution/strategy for economic advancement may be fundamentaly flawed, since, by the professors own admission:
The Consumer Price Index overstates inflation. Nobody really knows by how much, but Boskin and company made a guesstimate of 1.1 percent annually. Compounded over decades, this is a huge error.
In Mervin King’s letter to the Chancellor last week, he blamed the record CPI on “a sharp increase in energy prices during the second half of last year” which he feels ” more than offset the fall in petrol prices”. King also blames the record inflation rate on a rise in food prices caused by “bad weather”. This – King states – accounts for one half of the CPI pick up over the past year, which has risen to 3.1% from 1.8% this time last year. King points to this “upside” in inflation, which forced the bank to raise interest rates by 75 basis points over the past couple of months. Most economists are predicting imminent rate rises in light of the inflation figures and to a lesser degree, the strong pound against the dollar.
Although Gordon Brown appears satisfied with this strategy, Kings argument for rate rises is not flawless, because if rising interest rates were the cure against rising inflation, then the interest rate rises in August last year and the “surprise” rate rise this past January should have curbed the inflation rate, but this has not happened.
Furthermore, King is blaming the rise in inflation on energy prices and the weather, all aspects of human life that he has absolutely no control over. So if King and the bank of England have no control over the causes of inflation, how can we realistically expect him to have the cure?
BoE – rates on hold "for now"
March 21, 2007 at 12:35 pm | In bank of england, economy, interest rate | Leave a CommentBank of England minutes released this morning showed one policy maker voted for a rate cut this month and none wanted a hike. “That’s quite surprising. As you know the general feeling has been that there is one more hike left in the pipeline yet,” said Richard Hunter, head of UK equities at Hargreaves Lansdown
[Reuters]
UK inflation at record levels
January 16, 2007 at 5:08 pm | In bank of england, ecb, economy, inflation, interest rate | Leave a Comment
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.
EU interest rates
January 11, 2007 at 3:03 pm | In UK, bank of england, economy, interest rate | Leave a CommentBoE raises 0.25 percent to 5.25%, but the ECB holds steady at 3.5%, causing the euro to once again strengthen against the dollar.
From the BoE press release:
In the United Kingdom, output continues to rise at a firm pace. Domestic demand has grown steadily and credit and broad money growth remain rapid. The international economy continues to grow strongly.
Sterling has risen and oil prices have fallen back. But the margin of spare capacity in the economy appears limited, adding to domestic pricing pressures. CPI inflation was 2.7% in November. It is likely that inflation will rise further above the target in the near term, but then fall back as energy and import price inflation abate. Relative to the November Inflation Report, the risks to inflation now appear more to the upside
Asking prices "at a standstill, no need for rate rise" claim Rightmove
September 18, 2006 at 4:52 am | In UK, bank of england, economy, ftse, housing market, interest rate, rightmove, stock market | Leave a CommentIn their latest survey to be released today, Rightmove plc said that the number of properties coming onto the UK residential market fell to their lowest since the start of the year, while stocks of properties on agents’ books also fell.
Normally, a dwindling supply of homes would herald a pick up in house prices if demand holds up. But Rightmove expects inflation to level off as recent house price gains conspire with higher borrowing costs to make it increasingly expensive for first-time buyers to get a foot on the property ladder.
“Asking prices are at a virtual standstill, the market appears to be correcting affordability issues itself and does not need further intervention from the Bank of England.” Rightmove director, Miles Shipside was quoted as saying.
In other Rightmove news; the company’s former director Grenville Turner is slated to head Countywide, the UK’s largest estate agency as it heads for a £900m stock market exit.
Abbey responds to the Bank of England’s decision to hold base rate at 4.75%
September 7, 2006 at 1:32 pm | In bank of england, economy, interest rate | Leave a CommentBarry Naisbitt, Chief Economist, Abbey:
“The Bank of England held rates at 4.75% today, probably reflecting a ‘wait and see’ approach following the increase last month. The Monetary Policy Committee members will probably want to evaluate the incoming economic news and assess whether the change made last month has had any impact on economic activity and inflation expectations. The economic news over the past month has not been sufficiently dramatic to alter the markets’ expectations of a further base rate rise, however.
“The market focus is on November when the next Inflation Report will be published. Given the decision last month, there will be the usual speculation on whether any of the Monetary Policy Committee members voted to raise rates. Given the medium-term inflation projection presented last month, I suspect that the decision to hold rates today may not have been unanimous – but we’ll have to wait for the publication of the Minutes to find out the details.”
For further information please contact:
David Stewart
Tel: 0207 756 4199
Email: David.Stewart@abbey.com
The ECB and Housing – a problem that needs to be cooled
August 31, 2006 at 4:00 pm | In ecb, economy, europe, housing market, interest rate | Leave a CommentThe ECB announced today, their decision to hold European rates steady at 3%. With regards to housing ECB President Jean-Claude Trichet stated in the press conference that housing was “a real problem that has to be cooled” Trichet described housing as a dynamic element of the overall European economy, even if it wasn’t “so much of a problem in Germany, but it’s changing.” Trichet stated that the ECB’s priority was to cool down “abnormal behavoir”. Click here for the press conference. His comments on housing are 41 minutes into the webcast
UK House price average near £200K
August 8, 2006 at 7:41 am | In UK, bubble, economy, forecast, housing market, inflation, interest rate, land registry | Leave a CommentThe registry’s figures show that annual house price inflation was at its highest, at more than 11%, in the north and north-west of England. The key London market saw prices rise by more than 8%.
At the other end of the scale, prices increased by 4% in East Anglia and by 4.4% in the East Midlands.
However, this is still ahead of general price inflation and rises in average earnings.
Overall, the Land Registry report indicated that prices have risen in all parts of England and Wales during spring and summer.
The Land Registry’s findings echo those of recent house price surveys by the Halifax and Nationwide.
Both groups noted that house price inflation – particularly in London – has beaten analysts’ forecasts so far this year.
As a result, last week the Halifax upped its forecast for house price inflation in 2006 from 3% to 5%.
But last week’s increase in UK interest rates to 4.75%, may dampen housing market demand, experts say.
via BBC
Interest rates on the rise
August 7, 2006 at 11:18 am | In bank of england, federal reserve, interest rate | Leave a CommentIn recent weeks, central banks in Denmark, Japan, Russia, Europe, the UK, Australia and even Pakistan have all raised interst rates to varying degrees. Tomorrow the Federal Reserve decides the fate of the US dollar, the world’s reserve currency. There is of course a strong relationship between interest rates and the housing economy. Both seem to directly affect each other in a “see-sawing” type of arrangement to control or “target” inflation. If house prices go up or inflate too high or too quickly, then that’s potentially bad for the economy and central bankers tend to limit money supply by raising rates, making it harder for consumers and developers to raise financing.
Once rates reach a certain level the overall economy cools – including housing growth, and things happilly go back to normal. Inflation is controlled and we can all go about our merry way … NOT.
Unfortunately in fiat economies, where the currencies are hedged mainly against consumer confidence, there are lots of other factors that can interfere with the above scenario. Wars, employment rates, tax rates, political stability, etc can all affect how a consumer “feels” about the econmy.
The above sentence may imply negetaive consumer sentiments, but the opposite also holds true. For example, even though the Fed has raised rates consistently for the past 18 months, the housing market still continues to inflate in many parts of the country. Witness some of the comments on today’s WSJ discussion on whether or not the Fed should raise rates tomorrow:
Romesh Chander: Here in Bellingham, WA, the housing prices are still rising; so, we need another raise of 1% in interest rates to bring it down to a reasonable level.
Carol May: I don’t know what kind of an interest rate rise it would take to really put the brakes on the LA housing market. It’s slowed a bit, but newly built condos, at prices generally upwards of $700K in LA proper, are still selling just fine. And builders are still planning and building like mad in the outlying ‘burbs.
Frank Szabo: Insane oil pricing is doing the job of interest rate raises for now.
In Japan, the opposite happened. For years, the central bank maintained a 0% interest rate, yet consumers refused to spend on anything even though money was riduculously cheap and the economy deflated. What happened there remains a mystery to many. We wonder patiently if Bernanke will give us the answers tomorrow.
RELATED POST: What did Mervyn say last night?
Zimbabwe Slashes Currency
August 2, 2006 at 11:04 am | In africa, economy, inflation, interest rate, zimbabwe | Leave a CommentAnd we thought we had it bad ??
The Zimbabwe central bank announces it’s slashing interest rates from 850% down to 300% and “knocking a few zero’s off of it’s currency”
allAfrica.com
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