Government’s preferred measure of inflation – CPI, has surged to 3.7% in December, despite Bank of England’s government Mervyn King writing four letters in a row to the Chancellor. The latest figure does not take into account the rise of VAT to 20%, which took effect on 4 January 2011.
Members of the MPC are jumping over each other saying that the spike in inflation is just temporary and it will be back to more comfortable level of 2% within one year. How many times have we heard it before? Does anybody really expect inflation to subdue by itself?
Let’s see what high inflation has in store for the UK:
1. Cost of living goes up, thus leaving household with less disposable income (in real terms), which eventually will hit real GDP.
2. Companies re-negotiating the pay deals with their employees, pay deals are often based on CPI, will have to offer higher pay rises, thus hitting the margins. Most likely companies will raise prices and thus drive inflation out of control.
3. High inflation will hit the poorest the most as food inflation usually outpaces other components. We have already seen gas and electricity companies raising the prices, but they are very slow to cut them as the price of oil and gas goes down.
It’s just a matter of time before Bank of England starts raising interest rates and markets already priced in an interest rate hike as early as first half of 2011 by pushing GBP/USD to 1.6000.