UK Inflation, Interest Rates and Employment

UK CPI for October remained steady at 3%, the same as the previous month, and already 50% above the Bank of England's 2% target. Meanwhile, RPI rose from 3.9% to 4%. Although, both CPI and RPI were marginally below the forecast figures, both show that inflation is becoming entrenched within the UK economy, as low productivity compounds the effects of a falling Pound, caused by Brexit, to push up costs. The CPI figure for food and non-alcoholic drinks rose by 4.1%, the highest since September 2013. Survey data also indicates that many producers and retailers, who have so far attempted to absorb higher input costs, have now reached a point whereby the squeeze this causes on their profits is no longer sustainable, so that they must all now collectively raise prices, or some of them will start to go bust, leading to increased unemployment, whilst those remaining in business will then be able to raise prices as the pressure of competition is reduced.

The inflation figure is flattered because on a year to year basis, some costs such as for fuel are lower. That is due to the fact that having initially increased at a rapid rate, the price of oil fell back, or rose only slightly, whilst the Pound having fallen sharply on the Brexit vote, recovered somewhat as a result of the US Federal Reserve ending its QE programme, and starting to raise official interest rates, which has led to a flight of hot money into safer havens such as ECB backed Eurozone bonds and securities, and UK securities, still backed by a Bank of England that has been resisting the need to raise official interest rates, and start to unwind its QE. But, in the last couple of months those conditions have also changed.

Expectations that the US will again raise interest rates in December, keep downward pressure on the Dollar, as speculators fear a sharp sell off of bonds. There has already been a significant sell-off of junk bonds in the last week or so. By contrast, the ECB has indicated that it will continue its QE programme for the next 9 months, which provides support for Eurozone bonds and securities, which thereby acts to draw in hot money, and drives up the value of the Euro. In the meantime, the Bank of England has also been forced to double its official interest rate from 0.25% to 0.50%, which as I had predicted, led to a further fall in the value of the Pound, rather than the conventional wisdom that interest rate rises cause an appreciation of the currency.

So, far, this further weakness of the Pound has not had time to pass through into higher inflation, as a result of higher import costs, but it will in the coming months. And, at the same time, the falls in the price of oil and other primary products over the last several months, are now being reversed, as the global economy start to grow much more quickly. In the last month or so, oil has risen from the $50 a barrel it had been stuck at for some time, to around $64 a barrel, and it looks set to move up to around $70 a barrel. Given that oil is an input into nearly every commodity, in one shape or another, either as raw material, or as energy to transport goods and materials around the economy, this rise in the oil price, along with a further weakening of the Pound, will push up UK inflation in the next few months, at a time when already UK wages are lagging some way behind inflation.

The Tories, and the Tory media are praying and hoping that this month's 3% inflation figure represents the peak, but it is unlikely to be the case, as the Pound resumes its fall, especially as fears over Brexit, and particularly a no deal Brexit, intensify in the weeks up to Christmas, and as the growth in the global economy, in China, drives up raw material, energy and food prices further, and whilst much stronger growth in the EU that is now coming through, as well as in the US, drives up manufactured commodity prices, and pressure on interest rates. The rise in interest rates in the UK, itself, by being passed on into mortgage rates, implies an approximately 6% rise in housing costs for owner-occupiers, reversing the situation over recent decades when continually falling and manipulated interest rates reduced those housing costs, whilst driving up the speculative bubble in house prices, and thereby also pushing up rents. 

As inflation continues to rise, whilst Brexit fears, and a further deterioration of Britain's competitiveness, due to stagnant productivity, continue to drive down the Pound, the Bank of England will find itself inevitably driven to raise interest rates further, but the consequence will then be to cause hot money to flee the UK – especially all of that hot money deposited by oligarchs of various countries that sought to use the UK as a tax haven – and so to drive the Pound even lower, causing inflation to rise further still. 

The UK is likely to experience the same phenomena as elsewhere that as interest rates rise, and the prices of assets such as shares, bonds and property fall sharply, the money leaving these asset classes, and all other speculative assets whose prices fall, will move either into consumption, driving up aggregate demand, and causing pressure for investment to meet this rising demand, or will indeed move into investment itself, as the owners of this money-capital find it more lucrative to invest in real capital, producing an average rate of profit, than to invest in speculative assets producing much lower yields, and whose prices are falling rapidly. In itself, the movement of money from hyper inflated assets into consumption or investment, will cause general inflation to rise as asset price deflate, and as the oceans of liquidity that have been created rush into commodity circulation. It is likely to cause a traditional price-wage spiral as this increase in consumption and investment leads to a scramble for labour-power in conditions where labour-power has already started to become relatively scarce, and so where firms will be prepared to utilise all of the available liquidity to raise their prices, and to raise wages accordingly.

The difference is that in Britain, Brexit means that already a lot of that actual investment in production will be relocating to the EU. The increased consumption will lead to increased imports of manufactured goods, pushing the UK's trade balance further into the red, and causing the Pound to fall further in value, pushing inflation higher still. The answer to that might be for the UK to impose controls on capital and imports, which is always the direction of travel towards autarky that such nationalist agendas such as Brexit lead to. As the Brexiters are threatening, a no deal Brexit would see them introduce high tariffs on imported goods and services, and form many the resort to WTO terms would mean that straight away. But, given the UK's dependence on imports in many areas, the effect of that will simply to push up domestic prices further, which can only result either in UK wages rising to compensate, or else an even more sharp fall in UK living standards as prices soar, whilst wages stagnate or fall, the latter especially as businesses relocate to the EU, and UK unemployment rises.

Capital controls and import quotas could act to prevent that, but the consequence then will be that UK prices will rise even faster, and UK living standards will fall even faster. UK consumers, including businesses who consume imports as components etc. buy imported commodities because they are cheaper. If they can no longer do so, and have to buy more expensive UK produced commodities, that will push up the prices of those goods and services. Moreover, if the UK were to go down such a route, it would certainly cause a response from other countries as it did in the 1930's, as they would establish import quotas and tariffs on UK goods and services. The major effedct of capitalism, in general, of reducing production costs is by producing on a large scale so as to enjoy the economies of scale, and indeed that is why larger economic units such as the EU we established in the first place. Having left the EU, Britain will already have lost a good part of that advantage of scale, but if it then faced further constraints as a result of other countries imposing sanctions on it as a tit for tat response to UK import quotas, etc, it would suffer much more.

As I wrote more than a year ago, Britain is head for stagflation, and that process which has unfolded over the last year is set to continue and intensify in the year ahead.