Archive for the ‘Inflation threat’ Category

Inflation Threat to Growth

Mercredi, mars 30th, 2011

An open trading nation such as the UK cannot afford to ignore the globalised markets and the effect e.g. of the cost of government debt and worldwide commodity prices. There is evidence of the merit in the continuing commitment of the Chancellor in his 23rd March Budget, to shrink the public spending deficit to 2 – 3% or thereabouts of GDP by 2015/16. Long-term interest rates are currently marked closer to those of benchmark Germany , rather than the considered more profligate Portugal, Greece and Spain, the latter economies all facing higher borrowing costs than the UK despite their lower budget deficits.
However, the Labour opposition, aided by the recent surge in oil prices and the negative growth (-0.5%) recorded in the last quarter of 2010, is still arguing that cutting the deficit too soon is harming growth and the living standards of the squeezed middle-income earners, citing the downgraded growth forecasts for 2011 and 2012 as evidence of this (refer also to Chairman’s Blog/Categories/Budget 23/03/11 in the right-hand index column).
More important for the Coalition government is that the independent Office for Budget Responsibility (OBR) has revised upwards growth forecasts for 2014/15 when the next general election could take place. Labour also has no real counter to the fuel price cuts to help households and small businesses or the raising of the lowest tax threshold above which people start paying tax to help the lower paid. Instead Ed. Miliband, with no apparent alternative policies ahead of the completion of his own policy reviews, is seemingly being drawn closer to the Trades Unions marching against cuts and, thereby, risking being viewed as an obstructive rather than constructive opposition leader by voters still doubting the overall competence of Labour on economic policy.
The main threat to the recovery of the economy in fact comes from inflation with the Consumer Price Index (CPI) at 4.4% and the Retail Price Index (RPI) at 5.5%. Higher inflation is responsible for the new OBR figures for the budget deficit with net borrowing in 2010/11 of £145.9 billion (£2.6 billion below what was forecasted but this undershoot less than expected by the markets). The OBR then predicts continuing overshoots starting with £4 billion on borrowing of £122 billion in 2011/12 and averaging £10 – 11 billion thereafter, due to the impact of inflation on benefits, public sector pensions and debt interest. Underlying this scenario is the assumption that average earnings will not be rising faster than inflation until 2013, with the Bank of England in order not to stifle growth, only allowing interest rates to slowly start to rise up later this year to average 1.8% in 2012 and 2.8% in 2013.
However, without a sharp drop in inflation next year as the effects of the recent increase in VAT and other such contributing factors fall away, an average CPI of over 4% (RPI 6%) in 2012/13 could trigger a jump in average earnings together with a bank rate at over 6% in 2013. The net result would be a squeeze on the economy equivalent to the effect of the cuts but without the offsetting stimulus of low interest rates.