By: Dr. Mike Campbell
UK inflation currently stands well above its 2% target rate which means that the Governor of the Bank of England, Mervyn King, will have to write to the chancellor to explain why. The consumer price index (CPI) currently stands at 4% on the basis of last month’s data and is up from 3% the previous month.
The Bank of England has left interest rates on hold at the historically low level of 05% for a further month, but it has been known for a long time that opinions amongst Monetary Policy Committee members are sharply divided. Some believe that low rates are needed to sustain and support the UK recovery, others think that inflationary pressure within the UK economy must be tackled by increasing rates which will choke off the money supply somewhat, curbing demand.
Increasing the VAT
As part of the UK government’s attempts to get the deficit and debt burden under control, VAT (a purchase tax) was increased from 17.5 to 20%. This, of course has already fed into UK CPI data. The austerity measures that the government is pursuing are likely to dampen economic output and could, therefore, lead to a reduction in inflationary pressure.
Mr King seemed to cover all possibilities in remarks made on Wednesday. Whilst accepting that in the short-term inflation would rise, he suggested that economic factors could cause inflation to overshoot or even undershoot its target this year. He also reiterated the fact that no decision had been taken on increasing interest rates, however, speculation in many quarters seems to back the likelihood of a rate rise before long – but then, on the other hand…
Any rate rise would be likely to send Sterling higher in the short-term, but if economic output starts to falter, fickle investors will abandon the currency in favour of safer harbours.