Fisher Investments Editorial Staff
Inflation, Developed Markets

Dear Chancellor

By, 05/19/2010
Story Highlights:
  • UK CPI rose to 3.7% y/y in April (highest in 17 months), up from 3.4% in the prior month, and a hair above the forecasted 3.5% increase. 
  • Factors contributing to the elevated CPI include a VAT increase, higher oil prices, and weak pound sterling.
  • Recent benign inflation readings out of larger economies, like the US, Japan, and Germany show inflation isn't a near-term concern globally.

____________________________________________________________________________________

It's not a stretch to imagine our elected officials in Washington identifying Smith, Friedman, and Hayek as the starting outfield for the Nationals. Politicians have not always demonstrated a strong grasp of economic or business principles, which is one reason we don't envy Mervyn King, the governor of the Bank of England (BoE).

UK CPI rose to 3.7% y/y in April (highest in 17 months), up from 3.4% in the prior month, and a hair above the forecasted 3.5% increase. Also missing expectations was the Retail Price Index (RPI) coming in at 5.3% y/y, well above the 4.9% projected. As a result of inflation exceeding the targeted 2% by more than a full percentage point, the BoE governor was required to pen an explanatory letter to the Chancellor of the Exchequer "under the terms of their remit."

In the letter, the BoE governor outlines the inflationary issues and reiterates the BoE commitment to keep UK inflation close to the 2% target in the medium term. The Chancellor of the Exchequer undoubtedly has a firmer grasp of such issues than your run-of-the-mill politician. How much firmer is his grasp? We can't say for certain.

Milton Friedman, the economist, not the centerfielder, famously said, "Inflation is always and everywhere a monetary phenomenon." But even Milton knew that isn't purely true in the short run. Monetary policy is certainly loose in the UK as it is in virtually all major economies today, but it's not excess liquidity driving UK CPI higher.

As Mr. King points out in his missive, factors contributing to the elevated CPI include a value added tax (VAT) increase, higher oil prices, and a weak pound sterling. The short-term pricing pressure resulted in increased costs for various goods—notably food, footwear, and women's clothing. (Our sincerest apologies go out to any women in the UK shopping for summer holidays.). The good news is inflationary pressures resulting from these factors should prove temporary and will likely ease later this year.

Temporary or not, it's important to keep UK inflation in perspective. The UK economy accounts for a mere 3.7% of global GDP. That's not insignificant, but benign inflation readings from larger economies show rising inflation isn't a near-term concern globally. In the US—an economy 6.5 times larger than the UK—inflation is almost nonexistent. Firms worldwide still lack pricing power, capacity utilization remain relatively low, unemployment is elevated, and money isn't yet flowing through the global economy at a normal clip—all factors working against big price increases. 

Rampant global inflation is a far off risk. Now, it's more important for central banks to remain flexible and accommodative to keep the financial system on sound footing and boost the global economy. Let's hope that message doesn't get lost in any communications between central bankers and politicians. 

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

Click here to rate this article:



*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

Subscribe

Get a weekly roundup of our market insights.Sign up for the MarketMinder email newsletter. Learn more.