SIMON LAMBERT: Interest rates and inflation return to the “old normal”
Yesterday it was revealed that inflation had fallen back to 6.7 per cent, a figure that just two years ago would have been considered shockingly high, but is now seen as something to be happy about.
Although the CPI reading is still a considerable number, it is an important step on the path back to the “old normal”, where both interest rates and wage increases are higher than inflation.
This is Money readers won’t need to be reminded that falling inflation doesn’t mean life is getting cheaper, just that it’s getting more expensive at a slightly slower pace.
You will also be acutely aware that a combination of CPI inflation of 9.9 per cent in August last year and 6.7 per cent this year means the pound in your pocket has lost almost 17 per cent of its value in only two years.
On a downward slope: consumer price inflation fell to 6.7% in August; It is still very high, but the trend is going in the right direction
But the latest ONS inflation figures still contain two pieces of good news.
First, although inflation only slowly fell from 6.8 percent to 6.7 percent, this was a drop when it was widely forecast to rise to around 7.1 percent.
Second, core inflation – the reading that excludes volatile energy and food prices and highly taxed alcohol and tobacco – fell back to 6.2 percent from 6.9 percent in July.
These two things point to inflation going in the right direction, although it is very likely that a rise in oil prices driven by rising oil prices could push up the CPI next month.
However, inflation is falling and economists suggest it could be below 5 percent by the end of the year and continue to decline towards the 2 percent target throughout 2024.
A significant contraction in the money supply (the amount of new money created in the economy) also points to disinflationary pressure.
> What falling inflation means for you and where it could end up in 2023
Regardless of how quickly the CPI falls and whether the landing ends up being quite bumpy, it shouldn’t be long before the Bank of England’s base rate is above inflation.
The Bank’s monetary policy committee is widely forecast to raise rates again at midday today to 5.5 per cent, but there is a growing view that this may be the last hike.
This is a reversal from the inflation panic forecasts of early summer, when the base rate was tipped to exceed 6 percent.
By the end of 2023 we will be back to the point where the base rate is above inflation – that was the old normal.
Rates may not rise as much now, but they will potentially stay high for longer.
So if the Bank stays at 5.5 percent next year and the CPI falls as expected, by the end of 2023 we will be back to the point where the base rate is above inflation.
That was the old normal, before the financial crisis and unconventional monetary policy hit.
Since then, inflation has largely been above the base rate as the Bank of England kept interest rates at the floor.
This low rate world was the “new normal” that many expected to continue.
The recent inflation crisis that surprised central bankers abruptly put an end to that scenario and I suspect that many rate setters see the positive side of this rude awakening as a golden opportunity to return to the old normal.
Part of the old normal also involved wages rising faster than inflation, something we’ve returned to once again.
Although current pay growth of 8.5 per cent is unsustainable in the long term, employees across the UK will expect that, as inflation moderates, their pay rises will remain above that figure.
Businesses should get behind that idea, as it means a return to the world of real wage increases and people getting a little richer every year, a good thing for a consumer economy.
As inflation falls, savings rates can be expected to stay above it, meaning a real return for savers.
Put your money into NS&I’s one-year maximum plan now at 6.2 per cent and it might be below inflation now, but you should get a real return on your cash over the next twelve months.
But savers should remain on their guard. Yesterday’s numbers lowered rate hike expectations and that will trickle down to the best savings rates on the market.
Don’t expect many of those 6 percent-plus fixed-rate savings accounts to stick around.
A fortnight ago, I warned about disappearing savings offers and advised readers to sign up to our Savings Alerts.
Shortly after, Santander withdrew its successful 5.2 percent easy access account. Only in the morning did he notify that savers had until midnight to receive it.
If you were subscribed to our savings alerts, you would have known and had time to act, as we send emails to readers to warn them.
So if you’re not part of the gang yet, sign up for Savings Alerts here.