There is always an economist somewhere agonising about inflation. As we head towards Christmas with an inflation rate falling towards zero – it dipped to 0.3% in November – you might think they were mostly keeping their counsel.
Not a bit of it. The inflation worriers are out and about, spreading their gloomy message of imminent rising prices as the economy overheats uncontrollably post-Covid, post-Brexit.
Overheat? Surely that cannot be right when the economy is on track to be about 10% smaller at the end of the year than it was at the beginning, and is not expected by the Treasury’s official forecaster, the Office for Budget Responsibility, to recover its previous peak until the end of 2022.
An economic growth rate of 5.5% in 2021 and 6.6% in 2022 is the prediction from the OBR and forms the benchmark from which all Treasury decisions are made. This rate of growth may seem electrifying compared with the previous annual expansion of 1% to 2% seen over the past 10 years, but it is just playing catch-up and no more.
Over in the City, many analysts see it differently. They are concerned that the new year will bring such joy, mainly from widespread and successful vaccination programmes, that western economies will explode back to life in the summer. This supercharged recovery is something developed economies could cope with if industrial firms were ready and willing to match the extra demand with extra output to keep supply and demand in balance.
Not likely, say the inflation hawks. Brexit uncertainty, which has killed off any growth in business investment over the past four years, has combined with Covid-19 to hit Britain’s makers and producers hard. Expanding production will not be easy when so much of the kit used to make things is worn out and in need of an overhaul. Redundant workers will be displaced and not yet ready or able to join those industries that benefit from a bounce-back in activity.
That means, they say, that a return to a some form of new normal will lead to such a surge in demand for goods and services that businesses, faced with a relative scarcity of things to sell, can only respond by pushing up prices.
Making matters worse, central bank funds from their £1 trillion quantitative easing programmes, of which the Bank of England has supplied £875bn, will supercharge the trend. Funds yet to be lent to the corporate sector – and billions of pounds of central bank funds are sitting in the vaults of commercial banks – will fly out of the door as ultra-cheap loans.
The UK mortgage market, which was initially buoyed by Rishi Sunak’s temporary stamp duty cut and is now struggling while he refuses to maintain it beyond April next year, will be given extra legs, unaided by government subsidy. Consumers, desperate to cheer themselves up, will join the borrowing binge, further increasing the pressure on prices.
Without controls on the disbursement of central bank funds via higher interest rates, an overheating economy could see what in modern-day terms would be hyperinflation of 10% or more, the hawks believe.
David Owen, the chief European economist at the City firm Jefferies, said last week that this scenario could see the Bank cut rates in early 2021 into negative territory, to cope with the Brexit fallout, only to jack them up later in the year, to prevent overheating.
Some of this thinking appears to have filtered through to the public, as revealed in the Bank of England’s most recent attitudes study, which showed people expect inflation to leap over the next year to 3.8%.
It’s true there was an increase in inflation following the 2008 financial crisis, when it hit 5% in 2011, but it proved to be shortlived.
And that’s because the economy in the aftermath of the financial crash was full of nervous consumers, most of them stuck on the same wages – or worse – that they had enjoyed before 2008.
Without wage increases there can be no boom, at least not one that can be sustained. The government says it won’t pay public sector workers more than 1% next year in fairness to private sector workers who have seen their wages fall.
Maybe private sector wages will zoom ahead. It is possible. But even if this unlikely event were to take place next year, it is – like the OBR prediction for GDP – a matter of playing catch-up.
Even when unemployment was at a 40-year low in 2019, most of the rise in wages came from increases in the minimum wage. Obviously, that is welcome, but it shows that employers have no wish and no urgency to improve the living standards of their workers without being forced to do so. And that inflation is not a threat.
