Inflation is up. Apparently the answer might be higher interest rates again.
UK CPI rose from 2.6% to 2.9% in July. Predictably, that has strengthened the argument that interest rates may need to rise.
But perhaps we should look under the bonnet before reaching for the monetary-policy hammer.
The underlying numbers tell a rather more interesting story.
- Headline CPI: 2.9% ↑
- Core CPI: 2.6% — unchanged
- Services inflation: 3.4% ↓ from 3.6%
- Regular wage growth: 3.5%
- Vacancies: 707,000 — their lowest outside Covid since 2014
- Payrolled employment: down 78,000 year-on-year.
- GDP grew just 0.4% in Q2, with household consumption increasing only 0.3%. Production didn’t grow at all.
This isn’t obviously an economy suffering from rampant excess demand.
So what drove inflation upwards?
The ONS says the largest upward contribution came from housing and household services, particularly gas and electricity. Gas prices jumped 14.7% in July alone, largely following the Ofgem price-cap reset.
Meanwhile, producer input inflation actually fell from 7.4% to 4.9%, with input prices falling 1.7% in July alone. Crude-oil input prices fell 18% during the month.
Those aren’t insignificant details.
Yet Bank Rate is already 3.75%, and at July’s MPC meeting three of nine members wanted to increase it to 4%.
Why?
Increasing a British homeowner’s mortgage payment doesn’t produce gas.
Increasing an SME’s borrowing costs doesn’t produce oil.
Making investment less attractive doesn’t resolve an international commodity-price shock.
It simply suppresses domestic consumption, investment and employment sufficiently to offset inflation generated elsewhere.
Yes, monetary policy has a legitimate role in preventing imported inflation becoming embedded through wages, services and expectations.
But that’s precisely why you examine the underlying data.
Core inflation isn’t rising. Services inflation is falling. Wage growth is moderating. Vacancies are at decade lows. Employment is weakening.
Against that backdrop, automatically prescribing higher rates because headline CPI moved 30 basis points looks less like sophisticated economics and rather more like a highly qualified committee repeatedly pressing the only button it has.
Interest rates work.
But “interest rates can reduce inflation” and “interest rates address the cause of this inflation” are not the same proposition.
When inflation is demand-driven, higher rates attack the disease.
When inflation is externally driven, they risk attacking the patient until the temperature reading comes down.
Perhaps the MPC’s hawks should spend a little longer looking under the bonnet.
James Scott
MD
