Thursday, 13 January 2011

"La, la, la. Not listening, not listening." The Bank of England and the inflation threat


It is a while since I’ve commented on the extent to which our economic lords and masters are ignoring the damage that consistent above-trend inflation is doing. However I was prompted by the observation – from this source – that:

Most inflation is being caused by indirect taxation by the state

Now, while it is true that increases in VAT and in duty on fuel, fags and flying affect prices, this is not the full story. Over the past couple of years a range of excuses have been set out for our relatively high inflation rates – upward fluctuations in oil prices, poor grain harvests, bad weather and so on. Yet throughout all this – and even when rates of VAT were reduced temporarily – there was not let up in the rate of inflation exceeding both trend rate and the Bank of England’s forecast rate.

Back in February 2009, the Bank forecast that the inflation rate today would most probably be between 0% and 1%. They reckoned there was a 1-in-4 chance that prices would actually be falling (i.e. the Dreaded Deflation), and the chance of inflation being over 2% was put at well under 1-in-10.

Crank forward to February 2010 (just 9 months ago), and the Bank had nudged up their forecasts a bit - they now said inflation would most likely be between 0.5% and 1.5% by now. But they still thought there was a good chance of lower inflation, and still a 1-in-5 chance of deflation (despite the fact that the printing presses had been running in overdrive for a year).

And now? Well, today's CPI inflation has actually turned out to be over 3%. And even the Bank's own November forecast acknowledges its back on a rising track.

So there you have it, the Bank of England – along with plenty of others - has hitched its wagon to the idea that we face deflation which requires us to have, what are in effect, negative interest rates. And today the Bank confirmed that rates won’t rise. And this is despite a big hike in commodity prices, continuing concerns about food prices and the VAT increase.

While all this is going on the Treasury is jumping up and down on the high street banks asking why they aren’t lending any money.

U.K. Chancellor of the Exchequer George Osborne said Tuesday that the government is in discussions with banks to ensure they make a material and verifiable increase in lending to businesses, especially smaller firms.

So let’s think about this George. The banks aren’t very keen on retail lending at the minute despite the Government having printed plenty of money (alright I know they haven’t actually printed any more notes then usual but shovelling money into the banks’ balance sheets* amounts to the same hill of beans). Now why do you think this is? Why aren’t the banks lending?

Spotted it! Banks aren’t lending because they’re losing money doing so – and, quite understandably, banks are not especially keen on making more losses. All that money (along with the make-believe money from the Government) is sitting snugly in the banks’ virtual vaults waiting for interest rates to rise. And the banks know rates have to rise because inflation can’t be allowed to continue at current levels for much longer.

If the Bank and the Government want to stimulate lending the best way to do that is to raise interest rates. Right now the banks are making plenty of money doing their everyday transaction management and ‘moving money around’ business and see no real point or incentive to encourage risky small business lending. Plus, of course, raising rates would reduce inflationary pressures.

Unless, of course, the Bank and the Treasury are really rather pleased about above trend inflation – what better way to reduce the deficit and control the debt! At the expense of savers, shareholders and those who didn’t behave like Viv Nicholson during the last decade.

*Technically QE isn’t ‘monetising Government debt’ as the Government isn’t buying its own debt. Third parties (banks and so forth) are buying the government’s debt. And the assets bought by the bank with QE are different and separate from this. Or put simply – we give the banks cash and they (and their clients) buy government stocks. This is of course wholly different from ‘Mugabenomics’.


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