Stubborn Inflation And Loose Debt

26th June 09 - Stubborn inflation and loose debt

The main idea behind monetary stimulus in the UK (quantitative easing) and fiscal stimulus (cutting the rate of VAT) was to counteract the damaging affect upon debts of rapidly falling inflation and possible negative inflation. Indeed, deflation and recession brought on by the lack of credit as a result of the credit crunch. In reality, even these many months on, the rate of inflation in the UK is stubbornly sticking above the 2% mark, at any rate as measured by the Consumer Prices Index (CPI). The figure for May 09 was 2.2% and although this was a 16 month low, it only fell from 2.3% recorded in April. Why?

The biggest factor in inflation holding up was an increase in alcohol and tobacco prices. So we are boozing and puffing our way through the hard times? Not so. The higher prices are due to an increase in duties introduced in the April 09 budget. A child of 5 years could spot the dichotomy, down with VAT up with beer and fags. A second big factor in overall prices holding up was the pounds depreciation in the currency markets so that imported goods cost more at the docks. You might ask then, why did inflation fall at all. It was because the cost of food came down slightly as did electricity bills.

Commentators are divided as to how low UK inflation will fall. JP Morgan, the leading investment bank, predicts a low of 0.8% by September this year but back up to 3.1% in January 2010. Perhaps the actual level itself is less important than the risk of further money-printing priming the pump too much. A wild-card is oil. Over the past three months it has doubled in price from $35 a barrel to the current $70. It is not just the price at the pump to you and me but the estimated 20% effect on distribution costs.

Meanwhile, back in the land of UK debt, the UK Government has sold £7bn worth of gilts in the biggest syndicated sale of sovereign debt in history. This is the first time in four years that that the syndicated bond market for 25 year debt has been tapped. The coupon is 4.5%. Something wider than the usual auction to UK clearing banks had to be tried since this year alone some £220bn of debt has to be financed.

Stubborn inflation and loose debt. 4.5% bedfellows?

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