Monetary Policy

“There is still a good case for one final half-point hike in interest rates”, says IEA economist

Commenting on the latest ONS inflation figures, Julian Jessop, Economics Fellow at free market think tank the Institute of Economic Affairs, said:

“There was little to no cheer in the latest inflation data, but the Bank of England should not have to raise interest rates much further.

“The good news is that the headline rate of UK inflation has peaked, as it has in the US and the euro area. The CPI measure fell again in December, to 10.5 per cent, from 10.7 per cent in November and the high of 11.1 per cent in October. This mainly reflects lower fuel price inflation, but also lower inflation for many other goods including clothing and footwear and household goods.

“The bad news is, of course, that 10.5% is still far too high. Food price inflation continued to accelerate, from 16.4 per cent to 16.8 per cent on the CPI measure. ‘Core’ inflation (excluding food and energy) is proving sticky too, holding at 6.3 per cent, as services price inflation rose from 6.3 per cent to 6.8 per cent.

“This will rattle the hawks at the Bank of England who are worried that labour shortages are driving a ‘wage-price spiral’. Even if headline inflation plummets this year as global energy and food shocks unwind, underlying inflation could remain well above the Bank’s 2 per cent target.

“But these fears may be overdone. Wage growth is still running well below the current rate of inflation, so there is little sign of an upward spiral. In the meantime, inflation expectations are already coming down and the labour market is starting to cool.

“The monetary drivers of inflation have gone into reverse too. In general, higher wages can only raise overall inflation if this is accommodated by monetary policy or, put another way, if there is enough new money in the economy to pay higher wages. The reassuring point here is that growth in the money supply has now slowed sharply.

“There is still a good case for one final half-point hike in interest rates (to 4 per cent) to ram home the message that the Monetary Policy Committee is serious about getting inflation back down again to restore some credibility. But with monetary conditions already much tighter, and the full effect of last year’s rate increases yet to come through, the Bank may not have much more work to do.”