It takes some doing to get the two MPC hawks to change tack that sharply and it shows the level of worry over inflation.
“I’m cold. Can we go and join the others now?”
The MPC members noted that there’s two factors at play. First, that the stimulus from lower oil prices could well see slack in the economy taken up quicker than expected and could also lead to faster wage rises. Second, that the fall in oil prices could lead to lower inflation becoming entrenched.
It’s the second point that has them scared. They’ve seen the slack take longer to erode over the last year or so and so are worried that the low price stimulative effect may not play out as much as people expect. That’s a very wise line to take.
If lower inflation doesn’t boost the economy, to a great degree, then lower prices will filter through into all aspects of the economy, lowering inflation across the board and raising the risk of deflation. I feel we’re in a good place to weather that though and have enough domestic activity to not let low inflation become too deeply ingrained. It might be a very close thing though, especially with the election coming up which can cause economic activity to slow purely from uncertainty from businesses not willing to commit until the election is over.
The problem I’ve highlighted here is one that Europe should be very scared of as they don’t have the same level of activity to get through a period of low inflation.
The market has already pushed back rate expectations and this will go a long way to cementing those calls so we could well see the pound come under some new sustained pressure as others start to join the crowd. It’s going to be March before we get the first wage data of the new year so that’s plenty of time to have had other economic numbers out to give us a clue on the state of the economy. The months leading from here until the election are going to be a very big deciding factor in the fortunes of the UK this year.
