Inflation may have peaked, but it remains far too high
Marc Glendening writes for 1828
Prof. Len Shackleton quoted in The Express
“The dip in the headline rate of UK inflation (from 11.1 per cent in October to 10.7 per cent in November) is obviously welcome, but there is still a long way to go even to get close to the Bank of England’s 2 per cent target. Food price inflation is also still rising, which is a particular worry for low-income households.
“Fortunately, there are three main reasons to think that inflation will fall sharply in 2023. One is simply the favourable base effects, as the huge increases in the costs of energy and food over the past year drop out of the annual comparison. It is not necessary for prices to fall in order for inflation (the rate of change of prices) to fall.
“The second is the mounting evidence that pipeline pressures are fading, reflecting a combination of weaker demand and an easing of some of the global supply shortages. Business surveys show that input price inflation has already peaked and some costs, including oil and shipping, are now falling outright.
“The third factor is that monetary growth has slowed sharply. In particular, the annual growth rate of broad money, known as M4ex, has fallen from around 15 per cent in early 2021 to around 5 per cent now. Monetary trends are the main driver of overall inflation, but still widely ignored. The shocks to the supply of energy and food explain why their prices have risen more than others. Nonetheless, inflation is ultimately caused by too much money chasing too few goods.
“The rapid deceleration in the growth of the money supply matters far more than what happens to wages, which are also just one more relative price in the economy. But as it happens, pay pressures in the private sector (based on forward-looking data on pay settlements, not the backward-looking data on average earnings) appear to be easing too.
“Overall, the Bank of England has a little more work to do. But official interest rates, currently 3 per cent, do not need to rise much further, especially with monetary growth back under control. One or two more increases, taking rates to 4 per cent, should be sufficient to restore some credibility.
“The government also has a role to play. One big uncertainty is what happens to domestic energy bills after the universal price guarantees ends in the spring. But it is always better to allow markets to work properly rather than resort to crude interventions and price caps. This includes the housing market, where the restrictions on supply are a major contributor to the cost-of-living crisis.”
Notes to editors
Contact: [email protected] / 07763 365520
IEA spokespeople are available for interview and further comment.
The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems. The IEA is a registered educational charity and independent of all political parties.