Philip Shaw at Investec shares these concerns. He says that one of the first acts of the new Bank of England governor next summer might have to be to write a letter explaining why inflation is over three per cent.
Not everyone, though, is so worried. Michael Taylor at Lombard Street Research expects inflation to fall next year, ending 2013 well below its target rate, at 1.7 per cent. Today's labour market numbers provide one reason to believe him. They show that wage inflation remain very low; at 1.7 per cent it is 1.1 percentage points lower than a year ago. One reason for this is that, despite rising employment, there is still a massive excess supply of labour holding wages down. If we add together the unemployed, the economically inactive who’d like a job and part-time workers who'd rather work full-time, there are 6.28 million people who are unemployed or under-employed.
There are three reasons why economists disagree about the outlook for inflation:
1. What's going to happen to productivity growth? Since 2007, labour productivity has fallen. This has raised unit wage costs, despite low wage growth, which has made firms try to push up prices to prevent a severe squeeze on profit margins. Mr Crowe fears this process might continue. But Mr Taylor is more optimistic, believing the fall in productivity to be temporary. Today’s figures lend him a little support. They show that, despite a rise in employment, total hours worked fell by 0.3 per cent in the three months to June-August, as the average working week shrank. With GDP rising in this period according to the NIESR, this implies that productivity rose a little. It is, though, too soon to call this the start of a better trend.
2. How much pricing power do firms have? Official data here are mixed. Manufacturers have raised prices at an annualized rate of 4.5 per cent in the last three months, suggesting they have considerable pricing power. But retailers have cut prices in three of the last four months, suggesting little pricing power.
3. What’s going to happen to commodity prices? Mr Taylor believes that a weak global economy will force these down, to the benefit of UK inflation. But this is not certain.
All this matters for two reasons.
One is that the lower is inflation, the better will be the real returns on cash. If Mr Taylor is right that inflation will fall below two per cent next year, then, savers in the better Isas can look forward to a real return of over one per cent. That's not fantastic, but if Mr Taylor's pessimism about the global economy is also correct it might compare very well to equities. If, however, a stronger world economy keeps commodity and share prices high, cash returns could well lag behind shares.
Secondly, lower inflation will make it easier for the Bank of England to justify more quantitative easing. Inflation "will not act as a constraint on policy" says Mr Taylor. But Mr Crowe is less confident. Although he, like most economists, believes the Bank will announce more QE next month, he fears that persistent above-target inflation will "sap the enthusiasm" of the Bank for more QE next year.
One thing, though, is clear. The hope that an inflation target would eliminate uncertainty about inflation now seems mistaken.
