This article was written by Richard Horswill. All views and opinions expressed are strictly his own.
Central banks are led by the nose in terms of data provided to them surrounding consumer prices which will be no different in the wake of the latest UK CPI data. However, surely they can identify the specific causes of higher CPIs that they cannot control using interest rate policy? Continually using a hammer to crack a nut does not inspire confidence, particularly when the nut has already been broken. I can never fully understand how central bankers can exclaim continual concern over “inflation” and its potential resurgence whilst in the midst of a prolonged cost-of-living crisis which directly affects private disposable incomes - the consumer. I think one needs to firstly identify what inflation really is and then work backwards.
“Inflation – it is always and everywhere a monetary phenomenon. A result of too much money chasing too few goods or a more rapid increase in the quantity of money than of output” (Milton Friedman).
Based on the above definition, it might seem that “inflation” might not be the specific problem the UK, or come to that, the global economy currently has. Global banks, who provide the global economy with the required liquidity, have been generally tightening lending standards for the last two years due to yield curve inversion, and as a consequence, money supply cannot be the problem. This is particularly true of the UK which has basically been practicing austerity over the last two years.
Supply shock – an unexpected event that significantly alters the supply of a product or service, which in turn affects the price.
This second definition seems to be more akin to what has been happening in the UK and general global economy, and as such maybe this should be more of a consideration when an explanation of Central Bank policy is offered.
Back to UK CPI and CPIH, which is the new measure of the annual rate of UK consumer price inflation that includes owner occupiers’ housing costs. The main focus of the monthly rise and the largest upward contribution in the monthly change came from housing and household services mainly put down to electricity and gas prices, whilst the largest offsetting contribution came from recreation and culture. This basic data equation puts the Central Bank in an interesting position. Based upon the rise in both CPI and CPIH the mainstream might well suggest that any rate cuts should not be provided regardless of the weak last quarter, however, with the BoE having no control over energy prices, and the rise seemingly being attributed to the ongoing energy supply shock driven by geo-political factors and OPEC2 supply constraints, they might want to consider the offsetting contribution. Recreation and culture might well be being driven lower one might think due to the cost-of-living crisis, meaning that disposable income is constrained. If this is the case, then the central bank should absolutely look to cut rates and take pressure off a struggling populace and thus economy. While interest rates remain high, the central bank is contributing to higher costs, lower disposable incomes, a weaker economy and a flat growth dynamic which in practice should mean that rate cuts should be on the table in December and ongoing into the new year until they catch up with the eventual lags in monetary policy.
When combined with a Labour government intent on collapsing business in the UK, burdening them with higher costs in taxation and wages, the potential double whammy by the BoE and the new government to the short- and medium-term outlook looks pretty bleak.
“It’s the economy, stupid,” is the well know phrase for assisting changes in government and policy direction however, “it’s the consumer, stupid" that is a massive part of the equation that helps to lead the economy out of recessionary times, as confidence returns when higher levels of consumer spending influence the markets. Unfortunately, with a both the central bank and government acting in unison to extend consumers pain with added costs and unwelcome interference, we will certainly not see any green shoots in the UK economy this side of 2026 and likely beyond.
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