Inflation: it's going up

22 November 2016 | Markets and Economy


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Leo Schulz: 'Inflation; it's going up.' The value of sterling has fallen, and the cost of imports is going up. What do we need to know? My name is Leo Schulz, and I have with me Alexis Gray, an economist in the Investment Strategy Group at Vanguard Europe. Alexis, this is the latest Bank of England inflation fan chart. It has a much steeper upwards slope than the charts that they've been publishing up until recently. So what's going on here?

Alexis Gray: Well, that's right, Leo. What you can see here is that the Bank of England is basically forecasting that inflation is going to start to lift, and in fact overshoot this two-percent level, which is where they typically target. The reason inflation is that post-Brexit we've seen a big fall in sterling, and when you think about that it means that anything that we buy from overseas now costs more.

Leo Schulz: So what kind of things are we buying from overseas? What are we talking about there, Alexis?

Alexis Gray: Fuel – filling up your car is going to cost more money. If you go to buy groceries at the store, that will cost more. If you try to take an overseas holiday.

Leo Schulz: Now with the possible exception of an overseas holiday, these are day-to-day items that people have to buy, don't they?

Alexis Gray: I think that's true. The fall in sterling has positives and negatives. Clearly one of the negatives is that it's going to pinch your weekly budget. The benefit of a weaker pound is that it actually helps local businesses sell overseas. They become more competitive.

Leo Schulz: If we think about the consumers, as you talked about their budgets being pinched, and we think if the export competitiveness doesn't balance that out completely, then in fact we're in a position, are we not, where although we've got higher inflation, we may also have a contracting economy.

Alexis Gray: People will feel worse off. That's sort of the net-net of it. Unless you're the owner of an exporting company you may not directly feel the benefits.

Leo Schulz: So how would the Bank manage a situation then where although inflation's quite high, economic growth may be low to negative?

Alexis Gray: I think they're probably going to hold interest rates where they are; as you mentioned there's two competing forces here. One is that the Bank doesn't like higher inflation and would typically raise interest rates to try and prevent that, but at the same time the uncertainty of Brexit will probably be negative for economic growth, and they would want to cut interest rates. So I think balancing those two things out, the bank may just sit on hold and wait and see how the negotiation plays out.

Leo Schulz: Inflation's likely to be higher, but it is unlikely to lead to a significant change in monetary conditions. Alexis Gray, thank you very much.

Alexis Gray: Thanks, Leo.

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