MichaelCD - The Blog.

The thoughts of Michael Cadwallader. Coffee loving, history book reading, Cheshire man.

Friday, January 19, 2007

The Inflationary Rabbit's Escaped

Who’d have thought that inflation would be such a big topic in general conversation? Certainly not me, that’s why I relied on my blog to vent my opinions on why we were headed for higher inflation, last year. And, as inflation is a lagging indicator, it’s the effects of last summer we are feeling now. So, if the BofE had raised rates in May, more than likely the ‘shock’ that that would have produced, would have led to no renewed housing inflation, and a slow down in the high street instead of people continuing to overspend, so inflation would now be under control.

Even the media have come to this conclusion, now. For instance, the Sun’s Fergus Shanahan states in his column today:
The Bank has been sloppy too, waiting too long to act and letting inflation get a dangerous hold again which will be difficult to break.
What effect the rate rise will have is difficult to fathom. It's obvious that previous rate rises have not stopped inflation. However, from what they have said, the government and the Bank are convinced that inflationary pressure will reduce by the end of the year. Presumably, that will be due to the lowering of energy prices in the last five months, feeding down to lower prices in the high street.

They may have a point with regards to energy prices, as we have had a winter without a hint of frost and snow here in North Cheshire. It’s scheduled to change soon, but I am not exaggerating when I say that I can never remember a winter this mild. And, the same is true not just of the North of England, but the whole of England, the British Isles, Europe and the other side of the Atlantic. So, the result of mild weather has directly led to oil prices falling to a two-year low, stuck in the $50-55 barrel range. Natural Gas has suffered, too, with lower use of central heating.

But what goes around comes around. What the weather has given with one hand it has taken away with the other. Because of scorching drought in Australia, the grain harvest was severly affected. That has sent the grain price soaring, which will feed through into higher prices for all staple produces.

The effect of the wheat prices will not, however, be as inflationary as high oil prices, so all in all that could help to reduce inflationary pressure. So, with oil prices unlikely to go anywhere near $80's a barrel this year, perhaps the government are right not to worry too much. But, it could be only a temporary respite when you consider the China factor. And, finally, with retail prices still climbing, it suggests that inflationary pressure is still in the process of building up. Only when that falls will inflation likely to come down, and even then it will take a while to filter down.

All in all, I find it very difficult to see a situation where the Bank will be able to lower interest rates this year. So, any sign of a spiral towards stagnation or recession cannot be counteracted by an interest rate cut, without inflation being set free to wreak havoc.

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