Wednesday 17 February 2010

UK Inflation – February 2010 Update


Yesterday the Office of National Statistics reported the January 2010 UK Consumer Price Index (CPI) as 3.5% up from 2.9% and the UK Retail Price Index (RPI) as 3.7% up from 2.4%. It seems the records just keep being broken. Last month we had “the increase in the CPI annual rate of 1.0 per cent between November and December 2009 is the largest ever increase in the annual rate between two months” and this month we have an ”increase in VAT rate leads to record CPI monthly movement for a December to January period.”

The first chart is tracking the CHAW Index which is the RPI including All Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. The current level of the Index remains above the trend line however what is interesting is that the index is actually starting to fall. In December ’09 it stood at 218 and it is now at 217.9, a fall of 0.1. At first glance this might suggest that the Bank of England has it all under control and inflation is going to start falling towards their 2% CPI target. I’m not convinced as let’s look at what’s happened for the same period over the previous 10 years:
- December ’08 to January ’09, -1.8
- December ’07 to January ’08, -1.1
- December ’06 to January ’07, -1.1
- December ’05 to January ’06, -0.7
- December ’04 to January ’05, -1.0
- Then in order of the previous 5 years -0.4, -0.1, -0.1, -1.1 and -0.7

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of December the 12 month figure is 3.7% (as published by the ONS), the 6 month figure is 4.2% and the 3 month figure is 3.5% annualised. It will be interesting to see what happens next month as I still think the Bank of England are looking for all the excuses to sweet talk the market but are chasing a “little inflation”. This will ease the pain on those who are in debt. That is the government and the public who on average have over extended themselves. Those prudent savers (like myself) will of course be punished as the value of their assets is reduced.

The fact that CPI is so far above the 2% target prompted the Bank of England to write a letter to the Chancellor. What a read. Firstly the excuses:
- “the restoration of the standard rate of VAT to 17.5% is raising prices relative to a year ago.” I think it’s a little hypocritical to use this excuse. When the rate went from 17.5% to 15% a little over a year ago I don’t remember anyone using this effect to help explain why we were seeing deflation. Instead it was quick, panic, drop the Official Bank Rate to record lows and Quantitative Ease (QE). Now the boots on the other foot and we just ignore it.
- “oil prices have risen by around 70%.” Why no mention of the fact that they and the government managed to engineer a currency devaluation knowing that import prices will rise, causing the average punter to pay more for fuel, which feeds into CPI.
- “the effects of the sharp depreciation of sterling in 2007 and 2008 are continuing to feed through to consumer prices.” As mentioned above all engineered by the Bank and government and now it’s all oh well too bad at least we have an excuse.
Secondly, it is clear we should not worry as the Bank of England knows what it is doing [sic]. Inflation is well above target but the “low level of Bank Rate, will continue to provide a substantial boost to nominal spending for some time to come.” In case that wasn’t inflationary enough “it will continue to monitor the appropriate scale of the asset purchase programme and further purchases would be made should the outlook warrant them.”
Finally, “equally, if at some point in the future, the medium term outlook for inflation threatened to rise above the 2% target, the Committee would tighten monetary policy.” To me it looks like we are well above the 2% target and that’s why the Bank of England are writing the letter in the first place. The Bank of England next meets on the 04 March however this letter makes it clear. Interest rates won’t be raised and we still have the chance of yet more Quantitative Easing to come. How much more do they want to distort markets and force up asset prices through low interest rates. I hope the bond market soon stops all this nonsense and takes the decisions away from them.

It’s interesting to parallel this with another developed economy central bank. The Reserve Bank of Australia seems to have CPI in control at 2.1% after raising rates a number of times. They are clearly committed to their inflation target as the latest minutes show that the decision to hold rates last month was a close call and that rates would continue to rise in 2010 if the economy continued to grow.

One only has to look at the exchange rate between the countries today to see the attitudes of both banks demonstrated by the markets.

As I stated last month, all I can say is that I’m glad I own Index Linked Savings Certificates and Index Linked Gilts.

As always DYOR.

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