When will inflation hit the magic 2 per cent level? And what will happen when it does? Last week saw a ridiculous over-reaction to the news that annual consumer price rises had gone from 3.9 to 4 per cent.
Gilt yields shot up, with the ten-year rate on UK Government bonds going to nearly 4 per cent, while the Footsie lost 150 points – and all because of somewhat higher prices for alcohol, tobacco and air fares.
However, as anyone who is interested in markets will appreciate, when they behave in a seemingly irrational manner, they are trying to tell us something else. That something else was a wider reassessment of the pace at which interest rates are likely to decline globally.
Maybe the uptick in inflation in Europe and the US over the past couple of months had made them re-think. Maybe the sharp fall in bond yields had encouraged them to become a bit too gung-ho. The central bankers have certainly been trying to damp down expectations of the pace at which their rates might fall – as has the International Monetary Fund. Its deputy managing director, Gita Gopinath, says the fund expects rate cuts to come in the second half of the year, not the first.
Well, perhaps. But imagine what might happen here in the UK if inflation is back to 2 per cent in April. That is a realistic possibility. Indeed it is what forecasters at the Pantheon Macroeconomics consultancy expect and I agree with them.
Realistic possibility: Imagine what might happen here in the UK if inflation is back to 2 per cent in April
True, last spring I expected the consumer price index to be down to target level by the end of 2023, so the decline is running about four months later than I thought. But if you look at the trend over the past three months, the annualised headline rate is already below 2 per cent. While it may pick up next month, it is quite possible that by mid-summer it will be down to 1.5 per cent.
Think about the politics of that. We will have had some sort of expansionary Budget from Jeremy Hunt, and there will be a lot of pressure for a less restrictive monetary policy too.
The Bank of England will argue that it has to look to the longer-term trends, and that it would be irresponsible to cut rates too swiftly. But just as it was far too optimistic about inflation when it was on the up, now it is being too pessimistic as it comes down.
That 4 per cent CPI figure for December was disappointing, but it was much better than the Bank’s forecast of 4.6 per cent.
The Bank of England is independent, and rightly so. We don’t want politicians setting interest rates, as they did until 1997.
On the other hand, the reasons behind the poor judgment of the Bank – and of other major central banks – will have to be examined. Reform is inevitable, here and elsewhere. When inflation does fall below target, the central banks will have a hard job justifying any delay in cutting rates.
There will be other shifts. The excuses companies trot out when they put up prices will look much thinner. You can’t plead that your general costs have risen when they are falling – producer input prices were down 1.2 per cent month-on-month in December.
Stresses in the labour market will ease and most of us will surely hope the recent wave of strikes will recede. In short, a world where inflation is back in its cage will feel calmer and less troubled.
There are inevitably many other things that can go wrong. The attacks in the Red Sea have doubled shipping costs in the past month, and that seems almost a detail when set against the wider conflicts now taking place.
We should always remember the human tragedies happening alongside the economic damage, and even at home getting inflation down won’t fix everything.
However, come the summer, everyone will be more mindful of another matter: the upcoming General Election. It is impossible to predict how getting on top of inflation plays out in political terms, but it will establish a clear path to lower interest rates.
Coupled with the potential for tax cuts – or more accurately the reversal of previous tax increases – you can glimpse a lighter mood.
Indeed if you look at the housing market, that is already coming through. I see the US investment bank Morgan Stanley has just reversed its alarmist forecast of a 10 per cent crash in house prices, and about time too. We are not through to those sunlit uplands yet, but when the CPI goes below 2 per cent they will loom into sight.
