Bank of England Governor Mark Carney might be entitled to ask the Chancellor to cool down Cabinet infighting if he wants to curb inflation. Today we learned headline level of UK inflation was 2.6% in June. This annual change in consumer prices was a fallback from the 2.9% increase reported in May. But with wages increasing by just 2% over the past 12 months, this amounts to a substantial cut in the spending power of Brits, already paying food and fuel from foreign suppliers who view the pound less favourably since last summer’s vote for Brexit.
The fear for London’s households is that this gap between inflation and wage growth widens further in the next few months. British businesses are expected to take a cautious stand in upcoming pay negotiations and inflation is expected to increase to around 3% later in the summer.
This 3% threshold is an important one for the Bank. Under the terms of its policy independence, Carney must write to the Chancellor to explain what steps the Bank is taking to bring inflation back to its 2% target. As he sharpens his pencil, he could be forgiven if his initial draft included a line asking Philip Hammond’s Cabinet colleagues to stop behaving like squabbling children.
Investors domestically and internationally are watching the UK Government’s handling of Brexit negotiations and marking down the value of holding British assets, with the pound itself down 13% since last June. For an economy still running a budget deficit financed by “the generosity of strangers”, this is an unwelcome backdrop.
Sterling’s weakness and high inflation has inevitably led to siren voices calling for the Bank to raise interest rates and prop up the currency.
There are two important reasons this would be the wrong response when the Bank’s rate-setters next meet at the start of August. First, the present bout of inflation has been driven by the negative perception of the UK economy. This is tackled far more effectively through a more coherent approach to Brexit negotiations than encouraging fickle “yield hunters” into holding pounds. Second, the bounceback in global energy prices since early last year has also contributed to inflation being above target. Whether this persists will be determined by the dynamics of the major oil and gas producing nations in the Gulf, Russia and the US rather than actions closer to home.
But the challenges facing the Bank pale into insignificance when compared with those facing the Government. Volatile consumer prices lead to volatile politics.
It has ever been thus: the high inflation of the late Seventies did for Jim Callaghan’s government, and the fallout from the UK crashing out of the European Exchange Rate Mechanism in 1992 destroyed the economic credibility of John Major’s administration. Theresa May’s government might preside over a largely self-inflicted period of real wage cuts but her Cabinet does not have to search far for uncomfortable political precedents.
The warning signs are all there. Prices are back in the news every day. Many of the lightning rods for discontent in last month’s general election were inflation linked. Student-loan interest rates, at more than 6%, are priced off the UK’s Retail Price Index. Public-sector pay rises of 1% a year were possible last year as the economy enjoyed a temporary bout of deflation, but now split the Government and provide another angle for not so subtle leadership jostling in the Conservative Party. Opposition politicians offering to cancel student loans or break open public-sector pay settlements are little more than reactionary opportunists. Diffusing these important issues starts and ends with sound economic management.
Amid what is a sorry tale for London families there is one shred of comfort. Evidence from other economies is that global inflation may be peaking. In the US, inflation is down to 1.7% and in the eurozone it has fallen back to just 1.3%. So, if Hammond and co can get their act together, UK inflation could begin to ease in 2018. But on the evidence of the past 12 months, that’s a big if.
Simon French is chief economist at Panmure GordonReuse content