The past few years have been so full of gloom, in so many guises, that it takes some adjusting when there comes a piece of all-round good news. Yesterday’s inflation figures are that news. Not only did they show that the Consumer Prices Index has fallen – to 3.9 per cent, down from 4.7 per cent last month – but the drop exceeded market expectations by some margin.
A year ago, average earnings of UK workers in real terms – adjusted for inflation – were falling dramatically. Now it is the other way around. Average earnings are up more than seven per cent over the past year, meaning the average UK worker has enjoyed an effective pay rise of three per cent.
Of course, not everyone will be feeling well off, and real term pay rises are really just making up for last year’s real-terms fall. It is far from boom time. Mortgage rates, in particular, are continuing to eat into household budgets, as well as steep rent rises.
But the danger of a 1970s- style inflationary spiral is receding by the day. It is now looking more likely that the Bank of England will be confident to lower interest rates at some point next year, possibly several times. Look around the world, too, and it is a similar story. If the beast of inflation has not quite been slain then it is certainly cowering deep inside a cave. In the US, inflation is down to 3.1 per cent.
In China, the inflation index is actually down by 0.5 per cent over the past year – yes, while we have been fretting about rising prices, Chinese consumers have seen prices in the shops fall.
Given that the economic story of the past 30 years has been one of the West importing deflationary forces from China, it bodes well for the future path of inflation here, too. Over the past couple of years we have heard many people saying that the age of low inflation is over. But high inflation over the past couple of years is beginning to look more like a blip caused by the huge stimulus that governments pumped into the economy during Covid – at a time when the economy’s ability to produce goods and services was very constrained.
The one group of people who really don’t have any cause for celebration this week are the Bank of England’s economic forecasters. Having failed to see the inflationary surge coming, they now seem to be under-estimating the speed at which inflation is falling. As recently as August they predicted that it would be at 5 per cent by the end of this year, when in the event it is already over a percentage point lower than that.
It is a mirror image of 2021. In May of that year, the Bank’s Monetary Policy Report predicted that the Consumer Prices Index would rise no higher than 2.5 per cent in coming years. As we now know, it peaked at 11.1 per cent in October 2022.
Frankly, we might as well leave the job to the likes of Paul the Octopus, who was claimed to have successfully predicted the results of eight consecutive matches in the 2010 World Cup.
But the level of interest rates impacts on every household and business in the country. We ended up with an inflationary surge because rates were kept far too low for far too long. The problem didn’t just begin with Covid. It began in the depths of the 2008/09 financial crisis when the Bank lowered its base rate to 0.5 per cent – lower than anything seen in 300 years.
We were told it was an emergency measure to avert a slump turning into a repeat of the Great Depression. But as the economy recovered the Bank of England refused to budge. It kept rates at emergency levels, encouraging individuals and businesses to take on debts they could barely afford and inflating property prices and shares. Inevitably there was a big shake out when rates finally did rise.
Now, the danger is the opposite: that the Bank will keep rates too high for too long, suppressing the economy and imposing needless pain on borrowers. The Bank’s failures are so great it is a wonder Governor Andrew Bailey is still in his job.
When it was granted independence 25 years ago, the Governor was put under the obligation to write to the Chancellor explaining himself if inflation ever wandered more than one per cent either side of the target that the Government was set. For years, no Governor had to write a letter. But as for Bailey, he must have run out of ink months ago. Yet still he has been allowed to breeze on as if nothing had happened.
Finally we have some good economic news to celebrate. For once, wishes for a more prosperous New Year might ring true. But it is no thanks to Bailey and his Monetary Policy Committee. We are overdue a change at the Bank of England.
