Sterling falls after BoE makes emergency loan

By Richard Blackden

Sterling declined against the dollar as news that the Bank of England had lent

What lesson have we learned then? From a personal perspective I’d say I’ve learned the world revolves around money and that human financial behavior can be controlled to some extent by shifting interest rates down and up. Recent events have been most enlightening.

I do often wonder about the gap in perception of, for example, ‘inflation’ between yourself and a non-economist such as I. You probably hear the word and understand the concept in advanced economic terms, whereas all I know is that it is fundamentally in increase in the money supply and measured by RPI and CPI.

Therefore when you say inflation has peaked, I cannot help but think that more rises in oil prices, now that deflationary pressures from the developing world are decreasing, and that the pound is not rising against the dollar, could push up the CPI and RPI. This might not be ‘inflation’ as in people printing lots of money but if the BofE are targeted on 2% CPI surely it can affect interest rates as well as prices?

Reply: I see and experience inflation as you do. The CPI has been well below the typical experience of Uk consumers in recent months. The RPI has been closer to the average experience, and running at a much higher rate than CPI. Of course some prices will continue to go up, but I think we will find that the overall rate of price increases is less fast in the year ahead than it was in the year just gone. Wages are being kept under strong control. Inflation was brought on in the UK by the government borrowing too much and pushing too many bank notes out into the banking system with the help of the Bank of England. Now they are trying to rein this excess back in with higher interest rates and fewer notes being printed. The US sub prime collapse will help bring credit under control.

Should such inflation occur, and the BOE ups interest-rates, is there not a danger that the extra interest will increase debt thereby creating a demand for money that doesn’t already exist, creating a wave of inflationary pressure?

The way Labour have tried to create growth through debt and spending has produced a dangerous ‘interest-impetus’ which will not be easy to iron out.

Reply: A fall in sterling will push import prices up, but it will mean a further squeeze on our spending power. Watch wages - they are under reasonable control, and Brown is now for the first time this century putting a real squeeze on public sector pay. Whilst inflation is worse here than in the US or Euroland, it is not going to run out of control in my view.

Reply: There are no easy answers. The Central banks have made a large collective mistake by keeping rates too low for too long, inviting the debt mountains we now face. They now have to ensure enough liqudity and low enough interest rates in the system to prevent the protracted and damaging kind of squeeze Japan experienced for more than ten years from 1990. They also need to make sure they do not cut rates so much that they increase the propensity to borrow in an inflationary way. The problem at the moment is the reluctance to lend, not any great pressure to inflate, in both the US and Euroland.

The Uk is a bit different, because the government has been boosting demand artificially by borrowing so much. Inflation has risen higher here (on the RPI) and we still have to deal with the impact on food prices of the poor summer. Even so, I think we have seen the peak of the inflation in the UK. If the government wanted to help, it would start to increase productivity in the public sector, which would make an important contribution to curbing inflation. It has been increases in student fees, postal charges, rail fares and some other public sector costs that have boosted inflation.

Reply: No I don’t think there is much of a danger of strong inflationary pressures. The banks are going to be very cautious in how much they lend for bit.