Should U.K. Inflation Be Ignored?

July 21, 2008

David Blanchflower, a member of the Bank of England 9-person monetary policy committee and an economics professor at Dartmouth College, has publicly characterized the central bank stance as inappropriately tight.  He escalated his warnings today, suggesting that since Britain’s housing correction is likely to be as severe as America’s but without the offsetting macroeconomic easing of the Fed and U.S. Federal government, the U.K. will experience a deeper downturn than the United States.  Blanchflower believes that a period of substantial sub-trend growth will take care of the inflation problem that has the rest of the Policy Committee proceeding cautiously.  He is a labor economist by training and correctly predicted a softer labor market conditions this year.  Wages have posted a sub-4.0% year-on-year increase in five of the last six reported months, including an increase of 3.3% in the year to May, lowest in 11 months.  From Blanchflower’s perspective, worries about unglued inflation expectations are way overblown if the labor market is not in position to be a central part of that dynamic process.

The other side of the argument can be seen in the raw trends of both producer and consumer prices.  Producer output prices rose 10.0% y/y in June, twice their increase in the year to December 2007.  Between December and June, the PPI-O index advanced 15% an an annualized rate including 9.6% saar for its core components.  Core PPI-O posted 12-month increases of 2.7% last December but 6.3% in June 2008.  Britain’s producer input price index soared 30.3% y/y in June, up from 12.2% last December.  The consumer price index climbed 3.8% in the year to June, most since at least 1997 and up from 2.1% in December.  Over those six months, the CPI climbed at a 5.3% annualized pace, and the RPIX, which used to be what the Bank of England targeted at 2.5%,  advanced at a 6.9% pace. It will be hard to ignore these inflation numbers in an economy with a legacy of inflation binges before full jurisdiction over interest rate policy was ceded to the Bank of England in May 1997.  British inflation crested at 10.9% in late 1990 following the invasion of Kuwait and earlier spiked above 25% in 1975 and more than 20% in 1980-1.  These peaks were well above those in Germany or the United States and were associated with the first and second OPEC oil price shocks. Besides this year’s run-up in inflation, the U.K. also is running deficits in its fiscal accounts and the current account that approximate 4% of GDP.  These twin deficits, high and accelerating inflation, sinking economic growth, and falling interest rates when other central banks are not cutting their rates is a recipe for a currency sell-off.  British monetary authorities do not have any good options or good economic scenarios.  In such circumstances, it will be natural to tread slowly.  Whatever the policy committee majority decides will not lend enough support to please Blanchflower.



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