HAMISH MCRAE: War on inflation really is key…let’s hope rate hikes, more to come, kick it upside down
The pound had a decent week against the dollar and I wouldn’t be surprised to see it back at $1.40 in the coming months.
As noted here last week, there is a growing consensus that the dollar is now past its peak. This is good news for the UK, as even a modest recovery in the pound will put pressure on energy prices and thus inflation.
But there is also a growing mood – not yet consensus – that while inflation will fall sharply next year, it will get stuck after that. So maybe we’ll come back to something like 2 percent next year, but then inflation will pick up again and we’ll be at least 4 percent after that.
Balancing act: There is a growing mood – no consensus yet – that while inflation will fall sharply next year, it will then get stuck
If this does indeed happen, it will be a global thing, not particularly a British one, but that’s no consolation. We will get into the same rut as everyone else of trying to curb price increases to an acceptable level because all major central banks have made the same mistakes.
We will never see those near-zero interest rates or the flow of money from quantitative easing in our lifetimes. But we will be footing the bill for those policies for years to come.
The bill comes in three stages. The first is over; we are in the middle of the second; and the third is coming.
The part that is over is the rise in asset prices, the more speculative the asset, the bigger the bubble. Those bubbles have burst. Wealth that was never really there has evaporated, as it always would.
Take crypto currencies. The bubble hasn’t fully deflated yet, but I agree with the European Central Bank staff who wrote last week that Bitcoin was on its way to irrelevance – although I thought their claim that “Bitcoin has never been used to any significant extent for legal real-world transactions’ was a bit rough.
We should feel sorry for the small-time gamblers who lost their savings, but not the sophisticated institutions that supported the movement, or even the central banks that created the conditions that allowed the bubble to burst in the first place.
But that phase is over. What is happening now is the repricing of everything. You can see how that started in house prices here in the UK, which have now fallen for three months in a row. It’s happened to US high-tech stocks, with the Nasdaq index falling 28 percent this year. It’s happened with bond portfolios, where values have typically fallen by at least a quarter since January.
The only assets that have not fallen are those that were reasonably priced at the time. The FTSE100 index even rose 6 percent compared to the beginning of December last year.
This repricing will continue, with different types of assets determining what looks realistic and what doesn’t. I’m encouraged by the way the Footsie has performed because it represents great solid companies producing goods and services that people will always need.
The fact that it is trading higher than it was a year ago, after what has been a pretty awful period, suggests that people have been able to make common sense judgments about the value of these big companies. house prices? Well, they will take longer to find a stable level after the roaring ride of the past few years, but I don’t see a huge crash. People need houses.
All of this is predictable, at least broadly speaking. What is not predictable is the third phase of this whole sad story. That’s about how fast inflation falls, where it levels off and what happens then. We fly almost blind. It’s not just that central bankers got their inflation forecasts so wrong. Hardly any of them have any career experience of what happens when inflation is in the double digits.
That is why the growing fear that inflation will reach around 4 percent is so important. If that happens, there will be enormous pressure on central banks not to be too strict.
There will be a plea to increase the target percentage from 2 percent to perhaps 3 percent. Budget deficits will remain high. Work tensions will increase. Politicians who try to raise taxes will be voted out because the UK is not alone in opposing the austerity.
The 2020s may not be a social and economic catastrophe like the 1970s, but they will be a difficult, uncertain period for all of us. So let’s hope that these rate hikes, which we’ll see more of in the coming days, do indeed kick inflation upside down.