No interest or energy in suppressing inflation

This article was kindly published by Orthodox Conservatives

Inflation is back and “baked in” at North of 5% for the foreseeable future. I expect “official” inflation, which the Treasury calls Consumer Price Inflation (“CPI”) that is currently 5.5% to exceed 8% in the coming months.

You may be aware inflation is already at a 30 year high. In this piece, I will endeavour to set out:

  1. How we got to where we are;
  2. What we are likely to do next and why it won’t be effective;
  3. What we should do next.

How we got to where we are

Energy cost increases, (exacerbated by the Russian invasion of Ukraine), house prices, food products and second hand cars to name but a few are roaring at above double digits annual increases.

The government is culpable for relying on importing energy at wholesale market prices in its asinine pursuit of Net Zero.

Mortgage affordability criteria which was significantly toughened after the financial crash is under review, which may help first time buyers (and there are signs that finally, the relentless rise of house prices is beginning to slow).

A number of basic food stuffs, from vegetable oil to wheat and corn will be directly impacted by Russian sanctions as they are significant producers.

Net Zero is also to blame for second hand car prices escalating as the government is looking to phase out petrol and diesel aspirated internal combustion engines in new vehicles from 2030.

Under the terms of the Bank of England Act 1998 (which came into force on 1 June 1998) the Bank’s Monetary Policy Committee (“MPC”) was given sole responsibility for setting interest rates to meet the Government’s Retail Price Index (“RPI”) inflation target of 2.5%.

At the end of 2003, the Government changed the index from RPI to CPI and the inflation target to 2%.

Noting that CPI is currently 5.5% and RPI is currently 7.8%, it is easy to see why.

So what causes inflation? There are 3 principal causes:

  1. Prices rise due to increases in production costs, such as raw materials and wages (average wage inflation is currently 3.4%, well below both CPI and RPI inflation);
  2. Surge in demand for products and services can cause inflation as consumers are willing to pay more for particular products and services, particularly when demand outstrips supply;
  3. Loose monetary policy, for example the Bank of England continued with Quantitative Easing (also known as “printing money” or “QE”) for too long after the initial outbreak of COVID-19, increasing the amount of QE by £250Bn in just 8 months.

QE, used appropriately, lowers the cost of borrowing throughout the economy, including for the government. QE works by lowering the bond yield or “interest rate” on UK government debt (also known as bonds). It adds liquidity to support economic growth but if overused will, over time, stimulate inflation.

It is fair to say that all 3 drivers of inflation have contributed to its upturn with increases in material costs and consumer debt combining with additional QE to “bake in” the inflation we are now seeing.

What we are likely to do next and why it won’t be effective

Interest rates have been at or below 1% since March 2009, reaching a record low of 0.1% in March 2020 to coincide with the pandemic.

The last 2 meetings of the MPC have seen the base rate rise to 0.5% per annum. At the last meeting in February 2022, the rate increased from 0.25% to 0.5%. In short, it doubled.

There are 9 members of the MPC. 4 of them voted for a 0.5% increase to 0.75%. This would have trebled the base rate.

I expect the MPC to pursue a succession of increases in the base rate, which I expect will increase to at least 2%.

There are a number of issues with doing so:

  1. Increasing base interest rates is likely to lead to a rise in Sterling. This is good for travellers but not good for exporters as on top of inflation, their goods are more expensive due to exchange rates;
  2. Home owners on variable rate mortgages or trackers linked to the base rate will have to pay more each month to cover additional interest payments. This will inevitably lead to an increase in mortgage arrears and repossessions;
  3. Perhaps most importantly, it is too late. QE should have been lower and for a shorter period. Had interest rate rises been applied as early as Q1 of 2021, it would have helped to mitigate inflation. Now, it will simply add more unbudgeted cost to households, slow economic growth and inflation will still roar.

Millions of people already struggling with:

  • Increased energy bills from 1st April (and the prospect of a further hike in the energy price cap);
  • Increasing food costs;
  • Rising petrol/diesel costs;
  • Increase in National Insurance from 1st April;
  • Freezing of personal allowances;

all of which combined will reduce discretionary spending, which in turn will naturally lower inflation in the coming months.

With the economy only expected to grow by 4.9% in 2022, stagflation (where economic growth is below the rate of inflation) and “real terms” pay cuts (where average pay rises are below the rate of inflation) are creating a potential summer of discontent.

What we should do next

To avoid a sharp contraction in economic growth, I recommend the following immediate course of action:

  1. Reverse the proposed freeze on personal allowances;
  2. Reverse the proposed increase in National Insurance;
  3. Remove VAT on domestic fuel.

Rising petrol and diesel costs alone have delivered over £5Bn of additional unbudgeted revenue to the Treasury.

Recognising the situation in Ukraine is an economic and geopolitical “game changer” and that sanctions will damage the economy, I recommend the following short term course of action (next 90 days):

  1. Scrap the Bank of England Act and return control for setting interest rates to the Chancellor of the Exchequer;
  2. Taper increases in interest rates to a maximum of 1% during 2022;
  3. Abandon Net Zero. By importing over half our energy to keep our CO2 emissions below 1% of global output, the government has exposed the electorate to excessive risk. China, Russia, India and Germany alone produce far more CO2 than the United Kingdom and will do for years to come;
  4. Lift the moratorium on fracking;
  5. Maintain the 3 coal fired power stations currently in use;
  6. Stop the early decommissioning of existing nuclear power plants and return them to production;
  7. Remove the renewables levy on domestic fuel bills – it is a £9Bn+ stealth tax that helps fund renewable energy sources that would meaningfully mitigate consumer’s energy bills.

Beyond the next 3 months, the government must return the United Kingdom to energy self sufficiency as a priority. To do so, it must:

  1. Open up more licences for North Sea oil and gas exploration;
  2. Explore the feasibility of safely extracting the £1Trillion of shale gas in the Blackpool area;
  3. Explore the feasibility of extracting coal in Cumbria and Wales
  4. Begin the planning of 8 new mini nuclear plants around the coastline of the United Kingdom to deliver safe and affordable energy as part of a low carbon mixed energy supply by 2035.

We are living in a period of macroeconomic instability, which combined with the highest level of geopolitical instability since 1945, could have a severe, negative impact on the lives of millions of British subjects.

The government needs to act decisively, ditch Net Zero dogma and restore control over interest rate policy to the Chancellor of the Exchequer, whose possession it should never have left.

© justchrisdavies 2022

Published by justchrisdavies

Happily married. Thatcherite Conservative, hawk, libertarian, meritocrat, patriot, free speech, free markets, abhor all identity politics, woke/cancel culture/Critical Race Theory. Privilege is not exclusively white. Proud of my country, and it’s history. Support our armed forces. Refuse to bow to revisionism. The Laffer Curve will set us free. Lower taxes = higher tax receipts @justchrisdavies on Twitter, GETTR and Parler. Support GBNews, Fellow of the Bow Group, Member of the Bruges Group.

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