David Roberts

Look beyond the headline UK inflation figures

David Roberts

Few economies collapse from too little inflation but many do when it runs too high.

Much has been made of this week’s UK inflation data; at just 0.5%, prices have risen at the slowest pace in four years. Commentators and agitators are calling for ‘aggressive action’ from the Bank of England: presumably this means negative rates but that has been tried, tested and proven to fail to create inflation in Japan and Germany.

Of course, it would allow the government to pay even less than it currently does for the vast amount it has to borrow to support the economy (as a reminder, gilt yields are again at 500-year lows). This is perhaps good news for society and bondholders in the short term but a potential horror story for the future.

We make two points about this:

  • The last time inflation was at current levels, in 2016, we had just gone through the Brexit vote. Confidence had collapsed, the price of goods didn’t matter and few wanted to borrow to spend. And then inflation jumped to over 3% as pent-up demand from a ‘crisis’ much less severe than Covid-19 pushed prices higher.

     

  • Almost all the ‘fall’ in current inflation is attributed to petrol and leisure and almost nobody spent money on travel or eating out in May. The price really did not matter and those goods should have been removed from the CPI calculation basket. Reweight and replace with hand sanitisers, disposable gloves and toilet roll, not to mention home-delivered food, and inflation may well have been off (the upper end) of the charts.

 

As a taxpayer and UK citizen, I would say the less the Government has to pay for debt right now the better. However, if money is deemed free ‘forever’, where is the brake and the stabiliser that stops us ending up in an Argentina or Zimbabwe-like hyper inflationary-spiralling, currency-crippling UK 1970s-style mess?

Believing in free market economics, expecting an inflation ‘bounce’ (oil is already $70 per barrel off its lows) and with one eye on the long-term implications of negative rates suggests to me the Monetary Policy Committee must think very hard before reducing the base rate any further.

To finish, a parting thought for anyone thinking about buying five-year UK government debt. If you hold it to maturity as a long-term investor, your total return is zero so you had better hope inflation stays low. Of course, you could buy the high yield market instead: an income per annum above 5% produces a 25% return over five years, without factoring in any capital gain as the economy recovers – which is surely a better way to protect against inflation?

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Thursday, June 18, 2020, 9:58 AM