Is inflation a real risk for the UK economy?

If you owe a lot of money, you hope for inflation because it reduces the real value of your debts. My parents didn’t buy a bigger house in the early 1970s because they were fearful of taking on a mortgage of around £4,000.  It’s fair to say that my inheritance would be looking a fair bit better now if they’d risked it – within a few years, the real cost of that mortgage was negligible and the value of the house had multiplied many times, because of the inflation the UK saw in that decade.

It looks like inflation has been an unspoken but officially sanctioned strategy followed by the UK authorities for some years now. Not surprising perhaps when Government debt is over £1 Trillion now and growing at over £2 billion a week. How else do you explain the regular protestations of shock every month when the Governor of the Bank of England has to explain why inflation is above the official “target”. He has the tools to affect that but chooses not to – so you have to believe there is tacit approval for a strategy of “just enough inflation” to help reduce the real value of those scary debts.

But maybe the plan has been rumbled at last. There was shock last week when it was disclosed that Mervyn Davies, Governor of the Bank of England, voted in favour of more “quantitative easing” – pumping another £25 Billion into the UK economy.  Although he was outvoted by the full Monetary Policy Committee, the pound dropped like a stone and that, along with bad news from continental  Europe, (growth projections revised downwards, PMI data disappointing), sent the stock market into reverse.

Pumping money into the banking system is certainly having the desired effect on inflation, and is fuelling asset price strength. Look at property prices in London (let’s face it, the beneficiaries of money printing aren’t going to buy houses in Sunderland or Skelmersdale). Prices for tangible assets such as artworks, wine, classic cars are all strengthening.

But it only needs one external trigger I suspect to send inflation out of the significant but manageable zone (2-4 % perhaps) into something much worse. A dramatic fall in the pound could do that, which of course is a likely consequence of a money-printing strategy. Or oil prices increasing again, or perhaps a major security scare – North Korea? Then suddenly  inflation could be up to 5% and we’ll be in real trouble. It’s a while since we had a good old fashioned sterling crisis...

Now if inflation does rise, the weakness of organised labour these days means that strikes are not the risk we saw in the 1970s, when that bargaining power pushed wages up and got us into an inflationary spiral. But might there be a reaction against wage freezes in the public sector and for benefit payments, if inflation was at 5 or 6% rather than 3%? And private sector firms who could afford to keep up with inflation in their pay policy would risk stoking that inflationary spiral by their actions.

So, sorry for the Monday gloom, but we’d suggest that you might want to keep inflationary dangers on your risk register in terms of commodity and general price increases for goods and services – and have some mitigation strategies in place around inflation risks.  Also keep an eye on the UK’s credit rating (OK, since I wrote my first draft of this last week the first downgrade has come through), and currency volatility is another area of concern for business, with the UK risk appearing to be more on the side of the pound declining further. (But who really knows...)

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