King will not tolerate inflation increase

Jul 11 2008 by Ian Shepherdson, The Journal

THE Bank of England left interest rates unchanged yesterday despite a wave of appalling news on the state of the economy.

With the sole exception of the May retail sales numbers, which were boosted by abnormally warm weather, all the data has been terrible.

The housing market is dropping faster than a pebble in a mineshaft, sparking an alarming wave of construction job losses, while retailers are reporting dreadful sales numbers and even the manufacturing sector appears to be shrinking, despite the weak pound.

This has all been on the cards since last summer, when the ongoing turmoil in the markets began, but the emergence of hard evidence on the slowdown has not moved Mervyn King and his colleagues.

Their reluctance to cut rates reflects their fear that the surge in energy and food prices will feed back into higher pay deals, which will then allow companies across the broader economy to raise prices.

Back in the bad old days of the seventies, this was called the wage-price spiral, and it proved very hard to break.

So far, the evidence on wages is reasonably benign, at least from Mr King’s perspective, though that means most people are now facing a cut in living standards. This is what happens when economies suffer external shocks, and there’s nothing the Bank of England can do about it.

Indeed, if disaster strikes and wages accelerate, Mr King has made it clear he would rather raise interest rates in the teeth of a recession than tolerate an increase in broad inflation.

This all sets up an interesting few months, with Mr King likely to come under increasing political pressure from the fantastically unpopular Government to do something about the slowdown.

I think he will prove a tough opponent, and the more the clueless PM and Chancellor lean on him, the more he will resist. Ringside seats all round, please.

Ian Shepherdson is a former Wall Street and City economist now living in Newcastle. ishepherdson@hotmail.co.uk