Thought it couldn’t get any worse? Experts predict INFLATION is set to return in 2021 along with higher interest rates
Those who are long in the tooth can remember the horror of Black Wednesday in 1997 when interest rates briefly went up to 15% as the Chancellor attempted to end a sterling crisis prompted by linking the pound to the Euro in the ERM.
Thousands of home owners couldn’t pay their mortgages as their monthly payments went up and up with many selling their properties for less than they paid for it. And as for inflation the annual rate rose to more than 8% in the months that followed before slowly falling to around 4% and lower still into the 21st century. Since then we’ve got used to inflation at around 2% apart from a spike after the 2008 credit crunch – with interest rates nearer 1% for years. It’s led to a steady economy compared to the 20% inflation of the mid 1970s – the question is – will it return?
The 1970s saw inflation rise to more than 20% and mass industrial unrest
Inflationary pressures
There are a number of reasons why there could be a rise in inflation this year due to a unique set of factors. These include a consumer boom once the Covid-19 restrictions end, shortages of some imported goods due to Brexit and Covid hold ups, tax rises to pay for Covid and labour shortages in some sectors resulting in rising wage rates. If inflation rises then expect interest rates to follow upwards as well.
Two generations have lived in a low inflation Britain, but that could come to an end as the Government tries to wean the country off very low interest rates. Higher interest rates would help savers and those seeking to lend but hit consumers as those rates are passed on.
Then there’s the ‘magic money tree’ that is being harvested to pay for Covid. The Bank of England has used Quantitative Easing (QE) or in layman’s terms – printing money – to help pay all the bills. The Covid-19 crisis has cost the Exchequer billions – and so creating billions of pounds is a neat way to help pay for it – which puts inflationary pressures on the economy. Traditionally money was literally printed but now invisible Government bonds are sold to raise cash. This liquidity inevitably devalues the pound if left unchecked making sterling less valuable – it’s a trick that is difficult to pull off but so far the various Governments since the late 90s have managed it.
With Covid-19 has come a growing recession which is seeing a big rise in unemployment which dampens spending and acts as a brake on inflation. But at the same time revenue goes down and borrowing to pay for all those furloughed or out of work people rises. It all adds to the National Debt and Government borrowing.
And finally the effects of Brexit are still not known fully and won’t be for some months. Clearly imports of some goods from Europe will rise if only due to the paperwork – but what about the rest of the world? Could China, the USA, India and the Far East all see an opportunity to hike prices? It’s an unknown - but not one to discount.
The banking crisis in America triggered the 2008 slump
Catch a cold
Goldman Sachs in the USA made a prediction that inflation in America would rise this year as the economy picks up with Biden’s trillion dollar support scheme and the covid vaccination programme finally freeing up the economy. Their prediction was around 4% with the rate returning to 2% by the end of 2021. And they are not alone with Citigroup economists expecting inflation to rise along with many on Wall Street. If America sneezes the UK catches a cold as they say.
Image: The Sun
How it is measured
The inflation rate is calculated using the price increase of a defined product basket – and there are different baskets. The Office of National Statistics (ONS) produces three main estimates of inflation: the Consumer Prices Index (CPI) which is the most commonly used figure; the Consumer Prices Index including owner-occupiers' housing costs (CPIH); and the Retail Prices Index (RPI).
Pros and cons
One thing nobody wants is deflation – when prices and wages fall despite it sounding attractive – but it means the economy is not growing. Moderate inflation means wages rise allowing increased spending but also increased house prices and a host of items seen as an investment from gold to share prices. Firms that are on the up attract more investment and thus create more wealth, jobs and tax revenues for the government. Too much and we end up back in the 1970s and 1980s with high inflation and high unemployment.
A return to the Roaring 20s? We all know how that ended.
Conclusion
Trying to guess how the economy will perform in advance is an inexact science. As the Queen famously asked the head of the London School of Economics why no one saw the Credit Crunch coming in 2008 – even economists didn’t spot the signs as the American banks collapsed amid the sub-prime scandal – so as to how this year pans out is really a guess. It is most likely there will be a boom when the vaccination programme frees up normal life. Anecdotally many furloughed workers have been able to save money and have even been moonlighting or have spent money on their homes and thus increasing the value. Older wealthier people have not been able to go on holiday or dine out and are itching to enjoy their retirement and spend their pensions. Some have even talked of a repeat of the ‘Roaring 20s’, although we all know how that ended. The accepted wisdom is inflation will rise above 2% later this year and then fall back by Christmas. You read it here first.
Harry Mottram