The rise of UK inflation to 3% reveals how currency devaluation and money printing are poised to seriously impact living standards, furthering the spectre of inequality at home and abroad
A five-year high for inflation, combined with a depreciated pound, looks set to continue to depress UK living standards and reveals a series of negative economic feedback loops according to number of leading commentators.
Last week inflation at 3% was announced, the highest for 5 years, provoking a legion of reaction from financial professionals ahead of the Bank of England’s decision on interest rates at the end of next week. There is strong speculation that the Monetary Policy Committee on Threadneedle Street will vote for a rate rise to help counter and manage inflation that is currently well beyond its 2% target.
Writing on the Bank of England’s ‘Underground Bank’ blog site (not the Bank’s official viewpoint), Alex Tuckett, an analysis in the Banks’ monetary division, asserted that inflation was being compounded by drop in the value of the pound and put ‘real inflation’, or the increase in living costs, at 3.8% – nearly double the Bank’s stated target.
Tuckett identified a potential connection, or feedback loop, between inflation and currency valuation, comparing the UK’s prices with those in the EU to question the ‘Law of One Price’ that says arbitration will largely guarantee the same value in any currency. In seeing how the two price guides interact Tuckett claims inflation is heavily influenced by exchange rates, especially as they often move in response to economic outlooks – a factor often influenced itself by inflation.
“Amongst other things, exchange rates are influenced by central bank policy – and perceptions of policy to come. These and other results emphasise that the exchange rate is an important channel through which monetary policy in an open economy influences inflation. If exchange rates are always treated as a ‘conditioning assumptions’, this point can easily get lost.”
This was a point echoed by Bank of England governor, Mark Carney, who on October 17th told the Treasury Select Committee that the UK was particularly affected by exchange rate movements due to the nature of its economy.
Elsewhere, the ongoing uncertainty and complexity, over Brexit also represents a potential loop. Impacting growth and thereby the mandate for an interest rate rise – the Bank of England’s chief lever on inflation control. With the path of Britain’s exit from the EU still unclear and the pound down 10% since June 2016, this does not look set to change. Indeed, Julius Baer economist David A Meier told the press the Swiss bank remains “GBP bearish given Brexit-related uncertainties”.
Although markets seem to be pricing it in, Meier went on to question the logic of a rate rise at this time saying inflation should be seen as imported due to Brexit-related pound weakness and that “a rate hike seems like the wrong medicine at the wrong time. Uncertainties surrounding the Brexit remain ample and threaten to create more headwinds to sluggish economic momentum.”
The effect of rising inflation on the real economy has also been well highlighted. Conservative M.P. and Charles Stanley chief global strategist, John Redwood, called the rise to 3% “eye grabbing”, pointing to rises in petrol prices and councils tax and utility bills. However, like Meier, he played down the long lasting effects saying he saw this as peak level and claiming the Bank of England expected it to “subside in due course”.
However, this interpretation did little to quell market concerns. Jeremy Leach, CEO of Managing Partners Group, commented: “This is a continuing sign of creeping inflation and does not bode well for equities or bonds as gradual inflation will force higher interest rates that will make current equity and bond yields less attractive.” Leach went on to mention the 30th anniversary of the 1987 stock market crash, saying “we appear to be edging closer to the point where a market correction becomes inevitable”.
Leach’s identification of equity and bond yields being squeezed by higher interest rates is telling. Since quantitative easing the stock markets have benefitted from cheap money and record levels of investment, allowing those with capital to benefit from an ongoing bull-market while those unable to invest in assets outside currency remain vulnerable to rising prices.
Therefore inflation assessments have become particularly poignant in recent years as many predict significant rises in prices following almost a decade of quantitative easing. This is by no means limited to the UK: Writing in a series of notes around the Japanese election, Gavekal analyst Neil Newman highlighted living costs in Japan, where the central bank has undertaken an enormous quantitative easing programme.
Like Tuckett in the UK, Newman questioned the official inflation statistics (0.7%) and looked at the prices on the street, saying such subdued official figures for inflation are increasingly at odds with the experience of ordinary Japanese householders, who complain that their cost of living is rising at an accelerating pace. “The Tokyo salaryman will be hit with a 50% increase in the price of his Starbucks coffee next month. He has already seen a cheap haircut rise from ¥2,000 to ¥2,500, and the price of his shoes is up 20% over the last year. A quick bite and a beer after work is more expensive, too. This year, Torikizoku, a popular one-price Yakitori restaurant chain hiked its prices 6.7%, the first increase in 28 years. The price of beer went up 10% in June.” Like the UK, local taxes and utility bills are also up, with road tolls in Tokyo rising 37% over the last year.
All isn’t fair
Aside from the obvious implications of price rises, inflation has had more complex effects, as those unable to diversify assets out of the currency they are paid in lose wealth to rising prices. Arguably this equates to growing inequality as the poor get poorer and the rich get richer: in 2016 90% of the US population owned just 23% of the assets according to the Milton Group PLC. Federal Reserve figures recently suggested 39% of US wealth is owned by the top 1% of the population.
Anthony Rayner, multi-asset fund manager at Milton, highlighted technology and QE as potential reasons for inequality and protectionism and introspection as the symptoms. “What’s clear is that no one is taking responsibility for this worsening dynamic, partly because some of the underlying causes are difficult to identify, but also difficult to influence, with governments operating domestic policy levers in an environment dominated by global forces.”
Domestic monetary lever pullers are certainly aware of the challenge. In September Mark Carney highlighted the adverse effects of high inflation, saying it “hurts the least well off in society the most. It distorts price signals, inhibits investment, and ultimately damages the economy’s productive capacity.”
This level of inequality is destabilising on a number of levels, says Rayner, pointing to the World Economic Forum’s declaration that inequality will be the number one trend determining global developments in the next ten years. “At a country level, inequality has encouraged more extreme populist movements, often at the expense of traditional parties, as well as increased policy paralysis, for example in the UK and the US. Calls for concepts like Universal Basic Income, as well as taxing robots, will no doubt grow louder.”
The relationship between political instability and economic growth could well be seen as reciprocal and therefore formative of another loop identified by Rayner, that of growth vs indebted governments: “Policy makers will want higher wages, the obvious solution to inequality, but not so much so that interest rates have to rise sharply, as economies remain so indebted. Some central banks’ more recent preference for focusing on asset price excesses, rather than weak consumer price inflation, can also be framed within this inequality dynamic.” Given the levels of quantitative easing that led the central banks to own so much state debt, this bind could have significant consequences for monetary policy makers unable to escape the legacy of excessive money printing.
Rayner concludes that the “baton is slowly being passed to government”, as states look to replace monetary policy with fiscal policy. How the UK, and other states, deal with the complexities of their low growth economies – wages are currently shrinking by 0.8% year on year according to one investment firm, and the UK growth is the slowest among all EU economies over the last quarter – is yet to be established, but Mark Carney is certainly correct in identifying, as he did last week, that in the medium term “monetary policy can definitely affect nominal variables and real variables, in other words jobs and growth”. However, that means it can also affect inflation: proving that printing money does not mean printing wealth.
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