Fear not: there is little danger of inflation running wild

Next month the Bank of England might begin the long road back to higher interest rates. Plenty of financial traders believe comments and speeches by the governor Andrew Bailey and some of his colleagues make it a likely possibility.

If it doesn’t happen in November, the central bank’s monetary policy committee (MPC) will meet again in December to survey the economy. It could be then that the nine-strong group takes on the Grinch’s mantle, stealing Christmas cheer with a hike in the nation’s cost of borrowing.

MPC member and Bank of England chief economist Huw Pill said he expected inflation to hit 5% next year. His remarks followed comments by Bailey, who said the bank would “have to act” to quell inflationary pressures.

Only a week ago there were bets in financial markets of rate rises at both meetings, taking the current base rate of 0.1% to 0.5%.

Fears that rampant inflation would persuade workers to demand stellar wage rises, that in turn would stoke further inflationary pressures, are behind the impulse to act.

It was never clear how higher interest rates would influence consumer and business decision-making in the midst of a pandemic. A generous interpretation might be that it could deter spending, reducing the demand for goods in scarce supply and bringing inflation down quickly before expectations of a longer-run problem of rising prices become entrenched.

Mortgage customers who opted for variable or tracker loans were shaken by the clear threat of higher rates. Bank of England figures show a flurry of remortgaging in September, much of it on to fixed-rate loans. And who could blame them when financial markets were almost hysterical in their speculation of an early rate rise in the UK?

But au contraire, as Del Boy would say: an increase in the cost of credit is now as likely as the hero of Only Fools and Horses understanding French.

Danny Blanchflower, the Ivy League university professor and former MPC member, says a rate rise was always going to be “a stupid mistake”. With the economic outlook worsening, it has become an obviously stupid mistake, he says.

To give two members of the committee – Silvana Tenreyro and Catherine Mann – credit, they were never in the camp arguing for tighter policy. Tenreyro is the former LSE economist who joined the MPC in 2017 for the usual three-year term and was reappointed last year, while Mann joined in the summer from a Wall Street bank after stints in the White House and as chief economist of the OECD in Paris. They have made it clear the economy needs central bank support all through the pandemic, with low-cost credit, and that the difficulties faced by businesses and workers are far from over. Both the rising infection rate and tumbling consumer confidence support their view.

And these are not the only factors. On Friday, the Office for National Statistics said retail sales had fallen for the fifth month in a row in September. A survey of factory owners found that production stalled this month, after a period of slowing growth dating back to March.

While the services sector is growing strongly, it is doing so after many businesses were sideswiped by the pandemic. There is bound to be strong growth in a period of recovery. The same can be said when the chancellor, Rishi Sunak, boasts that the British economy is growing at the fastest pace in the G7: he forgets to mention that last year the UK economy contracted at the fastest rate in the G7.

It is difficult to know which way to step when there is a global shortage of goods coming from the Far East, much of it stuck in container ports where Covid outbreaks have forced the authorities to redirect ships to other locations. Who can say when this will end?

Brexit means there are also skills shortages in crucial industries, many of which are seeking to attract workers with higher wages. However, there is no sign of a runaway wages spiral of the kind that might send inflation into the stratosphere next year. Pay settlements are running at 2% and average wage rises, including promotions and bonuses, at 3.5% to 4%.

Bank officials will also be looking at Sunak’s spending plans. While he has doled out more than £400bn during the pandemic, he has begun winding down that support – witness the cut in universal credit worth £1,000 a year to claimants and the raft of tax rises slated for next year. Tax rises and benefits cuts will reduce household spending without the central bank moving a muscle.

No doubt the budget this week will be a confection of multibillion-pound handouts billed to solve climate change, regenerate distressed cities and level up the regions. Nothing will disguise its overall deflationary effect – spelling the end of rate-rise chatter.

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