Not surprisingly, the inflation hawks were out in force. Market Oracle led with a "shock, horror" headline:
UK CPI Inflation Soars Despite Bank of England Deflation Propaganda, Shocks Academic EconomistsAnd they showed this chart as evidence of what they called an "inflation mega-trend":
And Andrew Sentance, in a news release from Price Waterhouse Coopers, made the following pessimistic prognosis:
"UK inflation remains stubbornly above the 2% target. And with further energy and food price rises in the pipeline, it could rise further in the coming months. This would reinforce the squeeze on UK consumers and add to concerns about the Bank of England's ability to achieve its price stability objective. If above target inflation persists through next year, it will add to the pressure on the MPC to raise interest rates sooner rather than later."
Well, his first statement is correct. UK inflation has remained stubbornly above 2% since 2010. But this chart from Trading Economics shows that in fact it has been above 2% on average since 2005:
So given that, what on earth is the tearing hurry to bring it down to 2%?
Now, I will admit that this chart does show that there has been high inflation in the last two years - as indeed there was in the run-up to the financial crisis (really the BoE should have been paying more attention to the trend!). But since the peak of 5.2% in October 2011 the trend has been sharply downwards. In fact CPI inflation has been falling nearly as sharply as it did in 2009. Yes, there have been a couple of spikes, but there is no doubt that the underlying trend for the last year (at the time of writing) has been deflationary.
There are two possible ways of viewing the current spike. One is that it is just that - a spike - which will not affect the overall downward trend. If this is correct, then we should expect CPI inflation to fall again in November or December. In support of this argument, the ONS notes that of the 0.5% rise in CPI, 0.3% is due to a substantial increase in student tuition fees that has just come into force: this would unwind itself in due course. And as it also does not affect "ordinary" consumers, it is arguably a distortion. That leaves an increase of 0.2% due to externally-driven food and fuel rises partially offset by price falls in other sectors. If price-cutting continues in other sectors, CPI inflation may well return to trend even if world commodity prices continue to rise.
The alternative view is that this increase in CPI is a trend reversal - that the September figure was the turning point and this is the start of a rising trend in CPI inflation similar to that in 2010. This is clearly Sentance's view and it may also have been the reason for the MPC's decision to end the QE programme. Clearly the 0.3% rise due to tuition fees cannot be regarded as a trend reversal, since it is a one-off change. However, Sentance is probably correct that food and fuel will continue to rise in price, because the world price of essential foodstuffs is rising due to drought affecting supply, and the oil price is also rising due to world economic conditions. Furthermore, utility bills are expected to rise substantially in the next few months. If this is a trend reversal, price-cutting in other sectors will not be enough to offset inflation in these key sectors.
So it is by no means clear what the direction of CPI inflation will be over the next few months. What is clear, however, is that this month's CPI inflation increase is not due to pressure from a growing domestic economy. Here's the UK's GDP growth rate since 2008:
In the last quarter, the UK economy managed to grow by a measly 1%. Inflationary growth? Hardly. No, the CPI inflation increase is due to Government policy (the tuition fees increase) and external factors (rising price of commodities). So despite Sentance's gloomy prognosis, raising interest rates would not help. In fact it may make things worse. Many households and businesses are interest rate sensitive at the moment: a 50bps rise in the base rate, at a time when real incomes are falling, would increase the level of serious financial distress, with consequent impact on business production and consumer spending. Really it would not be clever to try to choke off a possible inflation trend reversal at the price of UK economic growth.
The Bank of England should hold its nerve and continue to support economic growth. Even if this is a trend reversal, inflation really is not the main issue at the moment.