Economists have warned the UK has a ’stickyflation’ problem as economic growth slows sharply while inflation rises quickly.
Following yesterday’s surprise jump in consumer prices index (CPI) inflation to three per cent, the Institute of Directors (IoD) said the combination will lead to difficult decisions for the Bank of England.
Graeme Leach, chief economist at the IoD, said: “We have a stickyflation problem, with a sharp slowdown in economic growth against the background of stubbornly resistant inflation.
“The rise in factory gate inflation also shows there are strong inflation pressures in the pipeline. The economic slowdown underway will eventually bring inflation under control, but the MPC will want to squeeze demand and inflationary expectations a little tighter before it can consider reducing rates again.”
The high inflation – a percentage point over the Bank of England’s target – means the rate-setting monetary policy committee (MPC) is now stuck in a dilemma.
On one side it is aiming to boost the economy with lower interest rates – encouraging borrowing and spending – but higher interest rates are needed to lower inflation through curbing spending.
Amid this the credit crunch remains a problem, as the Bank is being urged to lower rates to ease high borrowing costs.
Mr Leach added the upshot of the high inflation is while interest rates may come down, a solid round of rate cuts – with some analysts even predicting the base rate falling to 3.75 per cent – were now off the cards.
“Stickyflation and sticky interest rates look likely to be the economic story over the coming months,” the economist said.
“This does not preclude further interest rate reductions in the second half of 2008, but it does rule out aggressive Fed style easing, unless the economy weakens dramatically.”
All eyes now turn the Bank of England’s inflation report out today – which will signal where the central bank expects the CPI to head.
Julian Jessop, at Capital Economics, said: “The MPC will need to balance the deterioration in the inflation outlook against the deterioration in the growth outlook.
“Undoubtedly some MPC members, such as Tim Besley or Andrew Sentance, would put more weight on the former. But others seem to be starting to put more weight on the threat to activity.
“In particular, the minutes of April’s MPC meeting revealed that for some members the downside risks to inflation in the medium term had increased relative to the upside risks since the February Inflation Report.”
Commenting on the report in the housing market by the Royal Institution of Chartered Surveyors (Rics) out yesterday pointing to widespread – but not deep – house price falls, Mr Jessop said: “In short, the housing market slump is deepening.
“With the economy set to slow sharply, and activity likely to be further hampered by the continued tightening in lending criteria, we think house prices still have much further to fall.”
Share this article:
What are these?