The dilemma facing the Bank of England over monetary policy intensified last week with the release of the key inflation and employment figures. CPI rocketed again last month, this time by 0.6%, moving the annual rate from 3.8% in June to 4.4%. Furthermore many analysts are now confidently predicting an annual rate of 5.00% by Christmas. Of perhaps greater concern is the increase in RPI from 4.6% to 5.00% since it is this figure that wage demands are normally based on. At face value the inflation numbers demand a significant immediate tightening of monetary policy – a demand the Committee’s semi literate political masters may well insist on.
Both the Bank and the Treasury took some comfort from the fact that whilst prices are soaring, pay isn’t. Headline average earnings for the 3 months to June actually declined to 3.4% from May’s 3.8%. The fact that unemployment advanced on both counts – quarterly ILO measure rising by 60,000 and monthly claimant count up by 20,100 – may well be convincing the vast majority that large increases in pay would only lead to large losses of jobs.
Amidst all the hype and sloppy journalism (no change here) it is worth reminding ourselves of the Banks current actual remit: monetary policy to maintain CPI at (or close to) 2.00% over the medium-term time horizon. Thus a premature increase in Base Rate could cause inflation to fall significantly below target over the time frame as a consequence of collapsing domestic demand. It is possible to argue that the current Base Rate of 5.00% is acting efficiently against domestic inflation. As long as the current spike in food, fuel and commodity prices eases then this years price increases will fall out of the statistics. Therefore annual inflation will decline next year thus allowing the Bank to cut Base Rate to offset declines in domestic demand. It may be a one-off but last month China imported 7% less oil, is this a reaction to rocketing prices and a precursor to falling demand? If so then the Bank’s next move in Base Rate, and it will be down, could be just over the horizon.
