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As good as it gets

Created:
18 June 2008
Written by:
Algy Hall

From an inflation fighting perspective, the UK economy may actually be quite well-placed, however, that's unlikely to be of much comfort to those sectors at the sharp end of the fight.

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The Bank of England’s letter to explain May's above target consumer price index (CPI) inflation of 3.3 per cent hints that the economy is in fact very well calibrated to deal with surging commodity prices. Admittedly, inflation is now well above target, but in its letter the bank points out to the chancellor that it is dangerous for it to try to influence inflationary forces that are beyond its control. Indeed, the bank suggests that trying to bring CPI inflation back down to the 2 per cent target within the next 12 months would result in “unnecessary volatility in output and employment”.

In fact, in these circumstances, the biggest danger is that inflation will become deep rooted by spreading from commodity prices to rising wages and price hikes for unassociated products and services. According to the bank, the medicine to prevent this spread from happening is “for economic growth to slow” and as it happens, thanks to the credit crunch and falling house prices, that’s exactly what’s happening.

So reading between the lines, the bank looks like it’s minded to do nothing with interest rates, despite the prospect of a long period of above target inflation. That’s good news for the market which was getting increasingly fretful that rates were set to rise again. However, it offers little in the way of relief to investors in a number of hard pressed sectors such as builders and retailers. Indeed, the bank’s inference that the situation may well be bad enough already without it raising rates provides scant comfort. And the Treasury’s dicey finances mean that there is unlikely to be much help from this front in the form of tax cuts and the like. So, for the time being, it looks like vulnerable cyclical and consumer facing sectors will be left to take the pain in order to keep inflationary demons at bay.

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