Recent posts have warned that a surprising surge in inflation could put paid to hopes of early further interest rate cuts. A “triple whammy” of bad news this morning suggests this risk may be crystallising:
New projections in Wednesday’s Inflation Report may show annual CPI inflation peaking at close to 4% later this year and remaining at or above the 3.1% letter-writing threshold for six months or more (see here).
While surging world commodity prices have been the key factor driving inflation higher, the impact has been magnified by a 13% fall in the effective exchange rate from a peak last July – equivalent in magnitude to the 1967 devaluation, when Harold Wilson famously claimed “the pound in your pocket” would be unaffected. Many economists have cheered on this decline, arguing it was necessary to “rebalance” the economy away from consumer spending. In a speech in January, Mervyn King talked approvingly of a drop of almost 10% in the effective rate by then, adding helpfully that “ financial markets are pricing in a significant probability of a further decline”.
With the broad money supply M4 having risen 22% more than nominal GDP over the last three years, and the exchange rate sharply weaker, the surprise is that economists should be surprised by current inflationary problems.