The thinking here is clear. The Monetary Policy Committee’s mission is to bring inflation back to the official target of 2% and keep it at that level. Therefore, October’s inflation rate of 4.6% is still very high. The “core” rate excluding food and energy was even higher, at 5.7%, down only slightly from 6.1% in September.
There are also still some signs of continuing price pressures in other data, especially from the labor market. The Monetary Policy Committee is understandably concerned about the risks to its credibility if victory over inflation is declared too early.
But financial markets have already begun to make predictions about the timing of the first interest rate cut, and some are now speculating that it could come in the second quarter of next year. I would go further and suggest that inflation will also return to the 2% target much sooner than most people expect.
This is partly due to the collapse of money and credit growth. This serves as an early warning that inflation is about to surprise to the downside and that deflation (falling prices) may soon become the biggest threat. This may be a mirror image of the MPC’s earlier mistake in underestimating the upside risks associated with inflation when money growth was skyrocketing.
Of course, trends in monetary aggregates can be difficult to interpret. But other leading indicators of inflation tell the same story. Producer price inflation fell to zero, particularly in the food sector, and gasoline prices began to fall again.
We can also simply look at what is happening in other countries. In particular, UK inflation appears to be following US inflation with a time lag of about six months. This delay can be explained by earlier monetary tightening in the United States and the rapid acceleration of the decline in energy prices.
The labor market is often the last part of the economy to transform. Annual growth in regular wages (excluding bonuses) remained 7.7% in the three months to September. But timely data show that wage growth is now falling, too.
For example, early estimates from HMRC tax records suggest that annual growth in average wage growth slowed to 5.9% in October, with little change in monthly pay packages since June.
This is consistent with KPMG and REC UK’s latest jobs reports. Employers are still having to “raise wage offers to secure workers with the right skills,” which the market is behaving as it should, but overall primary salary inflation has fallen to its lowest level in 31 months. Job vacancies also decreased.
The result is that inflation is on track to return to the Bank of England’s 2% target early next year. The era of near-zero interest rates is over, but next year interest rates should end at around 4%.
Julian Jessop (@julianhjessop) is an independent economist