There are various reports out today which suggest that inflation could rise further than expected when figures are released later this week.Although the Bank of England has already acknowledged that inflation was likely to have risen above 3 per cent in January, it was then expected to fall below the 2 per cent target set by the Treasury.
However, others are not so optimistic.
For example, Investec predicts a 4.2 per cent inflation rate for January, more than double the 2 per cent target, due to the rise in VAT to 17.5%, higher petrol prices and the impact of the snow on food prices.
Citigroup has also predicted that inflation would be close to 4 per cent even at the end of the year, compared with the Bank’s forecast of close to 1 per cent.
Whilst the IMF has suggested that governments should allow for higher inflation in the future, this is the last thing any economy needs as it tries to recover from a recession, especially one in which the current Government has created unprecedented levels of public debt.
Whilst higher prices could lead to yet another blow to consumer confidence, there is another problem for any incoming government if inflation continues to remain high throughout the year.
At a time of economic austerity when there are expected to be massive cutbacks in public sector expenditure, a higher rate of inflation will lead to higher pay demands from public sector workers whose pay settlements, unlike those in the private sector, are normally linked directly to the rate of inflation. It will also lead to pressure to increase pensions, social security and other areas of expenditure which directly affect the general public.
Therefore, the next Government will not only have the issue of reducing the current deficit, but may well have to deal with increasing pressures on further expenditure due to the inability of the Bank of England to keep inflation under control.
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Leading economists say the government lacks a credible plan to cut Britain’s budget deficit and that action to reduce the country’s borrowing should start immediately after the election. In an endorsement of the Conservatives’ position and an attack on Labour — although the economists insist they are non-partisan — they warn that a failure to act could trigger a loss of confidence that could push up interest rates, undermine the pound and threaten the recovery. Signatories of a letter, published today in The Sunday Times, include the former chief economist of the International Monetary Fund, a former deputy governor of the Bank of England and head of the Financial Services Authority, and a former permanent secretary to the Treasury and cabinet secretary. Britain entered the financial crisis with a big underlying or “structural” budget deficit, the letter adds, which has widened sharply as a result of the recession.