It’s an economic disaster! The Bank of England has fumbled the bag and doomed us all - the UK economy is heading for a big crash! Or so you might be forgiven for thinking given some of the reaction to today’s announcement from the ONS that inflation has risen for the first time this year. It has crept up above the Bank of England’s target of 2 per cent to 2.2 per cent. While this is obviously less than ideal from the Bank’s perspective, there is absolutely nothing to worry about.
It’s important to point out that the Bank’s MPC is not to blame for this. The past two years have been characterised by the MPC’s repeated failures as it initially ignored the warning signs and allowed inflation to get out of control which plunged millions of households deeper into poverty. It then attempted to claw back some credibility by hiking interest rates too far and keeping them there for far too long. This has likely caused a great deal of damage to the country’s economy, the full extent of which will become clear in the coming months and years.
It has finally done the right thing by starting to cut interest rates and some commentators are asking whether the cut to Bank Rate has contributed to this increase in inflation. The answer is no. This is because the data released is for last month and, while monetary policy is a powerful tool, it has zero impact on the past. Moreover, there is often a lag when it comes to monetary policy so we would not expect for the effects to be felt for several months.
Even though the MPC is not to blame (a novel experience) did it still make a mistake in cutting rates given that inflation is above target?Again, the answer is no. An increase in inflation was already expected given that the base effects – energy prices falling by less than they did last year – was priced in. What is more, inflation actually increased by less than expected. Moreover, core inflation (which excludes food and energy prices) also fell by more than expected.
Furthermore, two things which had been worrying the MPC and meant that they took far too long to start cutting rates are starting to return to normal. First, services inflation – which has remained sticky over the past few months – also fell by more than had been forecast. Second, wage growth is the lowest that it has been in two years.
All of this suggests that although inflation is slightly above the Bank’s target, there is absolutely no danger of inflation getting out of control again and so there is no need to worry. In fact, policy makers at the Bank and HM Treasury should be far more worried about the fact that inflation is actually forecast to drop below the MPC’s target.
This is bad news as it suggests that there will be a lack of demand in the economy which is far more worrying than inflation being slightly above target.
It will mean that households will be spending less and firms will be investing less. This will lead to fewer businesses being started and a decrease in profits for firms. As such, there will be fewer new job opportunities and an increase in unemployment. All of this will exacerbate the UK’s low productivity and stagnant economic growth.
It could even lead to a painful recession and cause misery and suffering for people, with the young and very poorest being most adversely affected.
To avoid this, the Bank must resist calls for it to start reversing its loose monetary policy. Doing so would do further damage to our economy.
Instead, it should do the opposite and take the bold step of going further and faster on interest rate cuts. At the next MPC meeting in September it should vote to lower Bank Rate to 4 per cent.
This will mean that Bank Rate is more closely aligned with real interest rates while giving the economy the boost it needs.
The Bank of England has got a lot of things wrong over the past few years. However, it is not to blame for the recent uptick in inflation.What is more, this is nothing to worry about. We should all be more concerned about inflation falling below target and so the MPC must act now to stop this from happening.
