Worrying....

Yesterday we learned two pieces of information that lead us to believe that inflation is a real threat.

Wholesale food prices are rising at a record rate, in fact the highest rate since records began in 1992. In twelve months they have risen by 7.4%, or more than three times the rate of the CPI, which the Government insists on using. Grocery prices have risen by some 12% over the same period. (Behind these figures are the poor harvests last summer in some crops, and increasing world demand. World demand is also contributing to higher energy prices.)

U.K.factory gate prices, - that is prices before delivery and distribution costs, are also rising at a rate not seen for 17 years. They rose 5% in December 2007 alone. Factories have had to cope with an increase in the price of their raw materials of 11.2% in 2007, so there is little surprise.

Behind both indexes is the decline in the value of sterling against other currencies - anything imported may be the same price in foreign currency but will now cost (us) more in sterling. The decline in the value of sterling may be due partly to recent falls in interest rates, but as we have been running deficits for a few years of some magnitude it is more likely that the cause is a debt financed import binge by us

Some imports are also increasing in foreign currency prices, reflecting world shortages. These may also be magnified in prices we pay because of high taxes, for example on petrol were the tax is partly a percentage and rises with increases in the crude petrol price.

So our competent ex-chancellor has taken us back towards the situation in the 1970s, when we had "stagflation", a situation with both inflation and economic slowdown, when usually we would think of these as opposites.

The implications are many, but here I offer three.

1) The picture may be slightly more cheerful for exporting firms. Our exchange rate has declined, which means that our exports will be cheaper in foreign currencies, (except in the U.S. dollar, which has declined almost as much.)

2) For most of us, especially those whose pension or wages the Government is trying to control to less than 2% in order to try to control any wage cost element in inflation, there will have to be some belt tightening. Our real income, allowing for inflation, or our living standard, will fall. If we cut back on less essentials, the economy may decline even more. (One thing is certain, with inflationary pressures in the system, we can expect some public sector unions to decline offers of 2% each year over three years!)

3) Lower interest rates could stimulate the economy by making borrowing and credit cheaper, (although to some extent we are in the mess currently because we have lived too much on credit for many years), but if there is any inflationary pressure cutting rates could reinforce it. Lower rates may also cause sterling to fall further, as lenders decide to take their funds out of this country and need to change them from sterling into some other currency.

There are some optimists who feel that energy prices have peaked and will fall, and that consequently inflation will fall, aided by better harvests this year. They may be right, but if they are wrong and rates are cut we could see a further decline in sterling.

Who would want to lie on the bed of nails called the Monetary Policy Committee? Mervyn King the Governor, already seemingly the "fall guy" to deflect attention from Government failures over the Northern Rock fiasco, could well come under political fire over inflation/recession as well. As usual McCavity Brown will absent himself.