Inflation is now at a 3 year high at 2.3%. Despite the Bank of England target of 2% it is almost certain to go even higher in the next few months.
Now in the past the reaction of the Bank of England (BoE) would be to respond by increasing interest rates to dampen down the inflationary pressure. But interest rates have not yet gone up.
If this was a temporary rise before it settles down to the target of 2% then the BoE will resist putting up the rate of borrowing. But there are no signs that this is a temporary phenomenon – the lower pound is causing retailers to put up their prices, food prices are up, energy companies are putting up their prices. As the old song goes ” the only way is up.”
No this far from being temporary, inflation is back and here to stay. The only question is how high will it go up. Some economists predict 3% others say it will be higher.
But it’s not like the 1970s. Because of weak trade unions despite higher prices, wages are still stagnant. Combine the two and it gives a deflationary economy. So no pressure on rising interest rates. These factors will bring interest rates down to the BoE target without the bank having to use the usual anti-inflationary medicine.
But all this could change if sterling went further down. This would instantly increase the cost of imports and cause inflation to rise. This would force the Bank to take action to stop the financial markets selling sterling.
In such a scenario rising inflation would squeeze living standards but the Bank would have to then intervene by raising borrowing rates and could tip the economy into a recession.
The country would need this like a hole in the head at a time when there is so much uncertainty because of Brexit. Ironically, those that will suffer most are those very deprived communities that voted for leaving Europe. The weaker pound is a consequence of the move to leave. Another example of ‘be careful of what you wish for.’