Hard times. There couldn’t be a more fitting Charles Dickens novel for the moment we find ourselves in.
It began: “Only facts are necessary in life. Don’t plant anything else and uproot everything else. You can only train the minds of reasoning animals on facts: nothing else will ever be useful to them.
Printing money, even electronically, usually leads to inflation
So here are the facts – and they are very frightening for animals that reason like Money Marketing readers.
As a long-time skeptic of the Monetary Policy Committee (MPC), I was surprised when I calculated the average rate of inflation over its 25 years of existence. This year marks its silver jubilee – the first meeting took place on June 6, 1997 – marking a quarter of a century since the Bank of England (BoE) was freed from political pressure and allowed to set the rate of discount that the economy needed.
About once a month, nine people get together to do just that. Eight times out of 10, they decide to do nothing. When an adjustment is necessary, three times out of four, it is up or down by only a quarter of a point; as was the case in June when, against many expectations and the wishes of three of its members, the MPC changed the bank rate from 1% to 1.25%.
Earlier this year I waved around a ten, saying it would be a nine pound note by Christmas. Now that sounds optimistic
The US Federal Reserve, tackling rather lower inflation than what we have here, opted for a three-quarters of a percentage point hike from the same 1% base.
Long-term inflation in the UK
The objective of the MPC is to keep inflation as measured by the Consumer Price Index (CPI) at 2% (pedants will recall that it was 2.5% as measured by the RPIX [RPI All Items Excluding Mortgage Interest] until it changed in November 2003).
The arithmetic shows that, from June 1997 to the beginning of this year, the CPI increased by the equivalent of 2.03% per year.
But the latest rise in inflation threatens to derail this long-term success.
BoE data shows the average one-year fixed rate savings account yielding 0.89%. No one can live from this
CPI inflation hit 9.1% in May, and after more than a year of rising prices, the annual CPI increase over the 25-year MPC is accelerating.
The Bank, of course, expects annual inflation to return to 2% “in the medium term” because its policies are still working. But even she predicts it will be “slightly higher” at 11% in October.
Earlier this year I waved around a ten, saying it would be a nine pound note by Christmas. Now that sounds optimistic.
Shock inflation rise
This dizzying rise in inflation came out of nowhere. In July 2021, the CPI was right on target. Five months earlier, it was 0.4%. Now the CPI at 9.1% is the highest since February 1982 – but it was down then.
The Fed, tackling rather lower inflation than what we have here, opted for a three-quarters of a percentage point hike from the same 1% base.
It was in June 1979 that it last increased by 9.1% and it remained in the double digits until March 1982. So history tells us that we could be in for a long period of high inflation.
And the news too. Around the world, the end of most Covid restrictions is boosting demand. And the war reduces the supply. This iron rule of economics means that prices can only go one way.
The majority of the population has never seen anything like it. When inflation lasted, they weren’t born or too young to care.
Older readers will recall June 1979 when CPI inflation was 9.3% and rising (we called it 11.4% RPI [Retail Prices Index] then, which is 11.7% today).
History tells us that we could live for a long period of high inflation. And the news too
So the bank rate was 14%, mortgage rates were about to increase to 12.5%, and building society accounts were paying 7.75% on savings, which hit 10, 25% in November. Many retirees lived happily.
Today, with CPI inflation at 9.1%, the Bank Rate at 1.25%, two-year fixed rate mortgages are at a seven-year high of just over 3%, and BoE data shows average fixed rate savings over one year. account pays 0.89%. No one can live on that.
Tough times indeed.
Faced with finding a way to stimulate demand as inflation turned negative but the Bank Rate was cut to the bone, the BoE invented a second lever to control the economy: quantitative easing. He magically raised £895bn out of thin air.
There couldn’t be a more fitting Charles Dickens novel for the moment we find ourselves in.
It seemed to work at the time. But maybe too good. Printing money, even electronically, usually leads to inflation.
Unless the BoE finds a new magic lever to control inflation as it rages around the world, tougher times will come.
Paul Lewis is a financial journalist and host of Money Box on Radio 4
This article appeared in the August 2022 edition of MM.
If you would like to subscribe to the monthly magazine, please click on here.