Another month of low inflation in the UK. April CPI was up 0.3%, due to falls in air fares, vehicles, clothing and social housing rents which offset the rising oil price. The Bank of England is expecting inflation to pick up in the 2nd half of the year. They normally are.
When the BoE’s Quantitative Easing programme ended in 1212, the total amounted to £375 billion. One of the stated goals when the policy was introduced in 2009 was to bring inflation back to the target of 2%. In the years thereafter, cost push from commodity prices and VAT increases resulted in some high readings, with CPI up 5.2% in late 2011. Since then however, inflation has fallen back (if one is to believe the official figures, but that is another discussion).
Many market observers, this blog included, are expecting the increase in the money supply to eventually manifest itself in rising inflation. Why the wait? An obvious explanation is that the UK has run a continuous trade deficit for more than a decade, effectively spending the newly minted Pounds in export markets. Thus no resulting bottlenecks in the domestic economy, with low wage growth and capacity utilization.
Can the UK continue to run trade deficits and avoid inflationary pressures? It is possible. With production costs in the developing world a fraction of domestic costs, the potential for production to move to cheaper locations is vast. More products could become cheap imports as the domestic economy moves increasingly towards services. But there are risks. The increased supply could lead to a Sterling sell off, but that may not happen – the other major Central Banks have also been busy at the printing press. Or one day the funding for all this import spending may run out. It can only continue as long as foreign investor are willing to buy another London flat or another bankrupt steel mill. Once the appetite for UK assets evaporates the capital account will drop, and with it the trade balance. UK consumers will have to buy goods produced in the UK for their increasingly worthless Pounds. The export of manufacturing jobs will slow and bottlenecks will appear in the UK labour market. The latent inflation, saved up over years of monetary expansion, will appear.
The latest inflation figures show that we are not there yet. With growth weak, any rise in interest rates are therefore far off. Most observers recognise that the chances of a rate hike anytime soon is zero. People like Danny Blancflower, former MPC member, is openly advocating negative rates. The Office for Budget Responsibility even expects a cut. The forward curve is still upward sloping, but that has been the case for the so far 7 years of rock bottom rates.