Faced with war, central bank hawks must retreat on inflation | Philippe Inman

0

Russia’s attack on Ukraine poses a dilemma for the British government and the Bank of England with an obvious answer.

The dilemma centers on the cost of living crisis, which will only get worse now that gasoline prices are about to soar again and oil prices with them.

Seconds after the first Ukrainian reports of the invasion, traders pushed gas prices back up to levels seen in December last year. This is the month when prices reached nine times the five-year average, before falling back to five times the average in January.

Analysts have warned that household gas and electricity bills could rise by an additional £600-1,000 a year – up to £3,000 – if wholesale gas prices are kept high by an ongoing war.

Petrol prices, which in January appeared to have passed their peak when they began to fall towards £1.40 a litre, are returning to record highs of £1.50 and beyond. In some parts of the country they have already topped £1.60 a litre.

A spike in energy costs has put inflation on track to hit 7% or 8% by the spring, and possibly higher in the summer, eating away at the disposable incomes of middle-income people and plunging many of those on low wages in poverty.

The combined effect on the bottom two-thirds of households will be to slow down the economy, which has come to depend to a worrying degree, for a decade or more on government spending cuts, on consumer spending.

Rishi Sunak plans to deepen the cost of living crisis by raising taxes – National Insurance will rise by 1.25% in April and income tax will rise via a threshold freeze, bringing more people to pay taxes at the standard rate and more people to pay tax at the higher rate.

The Bank of England has its own program to raise borrowing costs for tens of thousands of small and medium-sized businesses and millions of mortgagers, who will face more expensive loans in the near future, if not immediately.

Prior to the Russian invasion of Ukraine, financial markets expected interest rates to rise by at least one percentage point this year. Some city economists believed Threadneedle Street was on track to raise the base rate to 2% by the middle of next year.

With soaring inflation, rising taxes and rising interest rates, it’s no wonder the GfK Consumer Confidence Index for February fell to -26. This was its lowest level since February last year and not far from its worst level on record of -34 when the pandemic took hold in April and May 2020. In February 2020 it was – 7.

It is true that many people are plotting to fly on vacation to spend their pandemic savings, but they are in the minority, albeit significant. Most people are reeling from their energy suppliers’ predictions of an extra £700, 800 or £900 on their energy bills this year, made before the war started.

Should the Bank of England continue its interest rate hikes to stifle even higher inflation? Should Sunak punch holes in everyone’s take home pay in April to rebuild public finances? The answers must be no and no.

Even staff at the International Monetary Fund, which gave its verdict on Britain’s economy last week and is not known for any socialist leanings, said the tax burden should be shifted to high earners to allow the Treasury to offer more support for middle and low income people. income.

The Washington-based lender of last resort, which will face a distinct dilemma this week when considering a request for financial assistance from the Ukrainian government, knows it would be foolish for British ministers to insist that, without offering additional financial support to the most affected, the energy crisis could plunge the economy into recession.

As for the Bank of England, it will have to let inflation rise without raising interest rates, knowing that the probability of a sharp squeeze in living standards will alone lower demand and reduce pressure on prices. .

It will be difficult for the anti-inflation warriors of Threadneedle Street to let prices rise and fall without action, but additional borrowing costs in the current environment, coupled with falling consumer spending, would make a recession almost certain l ‘next year.

It may seem callous to debate the economic situation in the UK as soldiers and civilians die. But it won’t help the Ukrainian people if British policymakers, along with their blind counterparts in the US and EU, drag the West into recession.

Fortunately, there is every reason to believe that the US Federal Reserve will resist raising interest rates at its next meeting, and the Bank should follow suit. This would send a positive signal: that at least the central banks understand.

Share.

About Author

Comments are closed.