UK Inflation problems persist and Greece's poker style gamble

20th April 2010 by Shaun Richards

Yesterday saw a further deterioration in the financial position of Greece. I think that this was caused by two main factors. Firstly investors are becoming more and more concerned by the risk of a further run on her banks. Secondly the dithering over whether there is going to be a rescue deal for her or not appears to just go on and on. I have discussed in previous articles the fact that Greece and the euro zone are playing what is in effect a game of poker for very high stakes and it would appear that by not actively calling for rescue Greece’s government are trying to raise the stakes one more notch. It is, in my view, a very dangerous gamble.

One other factor has emerged in the weakening of the Greek banks and that is that information has emerged from Deutsche bank that they hold 8% of the Greek bond market which is 38.4 billion euros. As you can imagine there will be losses on this portfolio. The net effect of all this was that the Athens stock markets fell by 2.6% yesterday as measured by the ASE index. Two of Greece’s bigger banks EFG Eurobank and Alpha bank were downgraded by Nomura and fell by 4% and 1.7% respectively. Greek ten-year government bond yields rose to over 7.6% and the spread with ten-year German bunds rose to over 4.5%.


We see today an issue of 3 month treasury bills in Greece and this will be keenly watched for obvious reasons. Last weeks issue of 6 month and 12 month treasury bills were 6/7 times oversubscribed but then we saw yields on them rise as somehow or the other all these extra buyers appeared to change their mind. I will be watching to see how this issue of 1.5 billion euros goes today and just as a benchmark last week Greek issued at 4.55% (6 months) and 4.85%(12 months). One would ordinarily expect 3 month rates to be slightly lower and the last sale on January 19th took place at 1.67%.

UK Inflation

Today sees the inflation figures for March 2010 in the UK. These are significant because the UK has shown disturbing signs of returning to inflation levels higher than those of her peers. They are also significant because we are going through a period where inflation is exceeding its target. Adding to this comes a failure of economic policy because many economists and the Bank of England were expecting UK inflation to be low or even negative (disinflation) at this time. Seeing as they set interest rates on a time horizon aiming around 18/24 months in the future then sustained rises in inflation represent a clear policy mistake. Regular readers of my articles will know that I have been concerned that we are in danger of letting the inflation genie out of the bag. When the inflation figures for February (23rd February) came out I wrote on this subject as follows.

Today’s inflation figures showed an interesting picture. I am sure many will concentrate on the fall in the Consumer Price Index to 3% in February and it may escape them to point out it is still 1% over target. They may miss the fact that the Retail Price Index for all items remains at 3.7%. Our previous measure which was used to target inflation was Retail Price Index excluding mortgage interest payment which is at 4.2% and fell by 0.4% compared with January. So it exceeds its “target” (2.5%) by more than the current measure

It did not surprise me to see many economists claiming that the UK’s dalliance with inflation was over as there is an element of saving face here when you look at their past forecasts. However I expressed concerns for the future pattern of inflation on the 1st April.

Inflation has in fact exceeded its target quite substantially when you consider that we have just gone through a year where economic output dropped by almost 5%. Last month inflation was 3% on the target measure and the month before it was 3.5%. With petrol prices having risen quite strongly so far this year there are reasons for thinking that inflation may well be higher this year than one would expect if one just looked at our economic growth figures. After all fuel prices influence many others as they feed through the economy.

Such thoughts were then added to by our producer price figures for March which showed signs of an oil price driven acceleration in input and output inflation. Indeed output price inflation rose to 5% and input price inflation rose to 10.1%. These figures on the 9th April led me to wonder about our Monetary Policy Committee.

Also it would appear if you look at the evidence that its policy on inflation is asymmetric as it keeps going over target and was reduced pretty much to panic measures when it thought targeted inflation would be under its target. 

Today’s Consumer Price Inflation Figures

These are very poor and are worse than the market was expecting. Consumer Price Inflation (CPI) has risen to 3.4% up from 3% in February and as this is 1.4% over its targeted level under ordinary circumstances the Governor of the Bank of England would have already written an explanatory letter to the Chancellor of the Exchequer (it is usually sent a day early).However his letter from February 2010 is still valid so in fact he will only have to write a new one if CPI remains more than 1% over target next month too.

The reasons  for the rise are “widespread” according to the Office for National Statistics with housing and household services (gas prices) being the highest contributor. Other fuel prices rose and increased transport costs but this was not the largest contributor.

Retail Price Index

In the year to March, Retail Price Index annual inflation was 4.4 per cent, up from 3.7 per cent in February. The main factors affecting the CPI also affected the RPI. Additionally there was significant upward pressure to the change in the RPI annual rate from housing as the impact of falling mortgage rates from a year ago fell out of the numbers.

Our Old Target RPIX

RPIX inflation – the all items RPI excluding mortgage interest payments – was 4.8 per cent in March, up from 4.2 per cent in February. Perhaps the most revealing of all the numbers as this was our previous inflation target and was set at 2.5% so it is some 2.3% over its target.


These are poor figures and to my mind they call into question the credibility of the Monetary Policy Committee. As I remarked above they moved into panic mode when they felt that the UK economy might move into negative inflation (disinflation) but seem rather complacent when it rises to the upside. Their policy of Quantitative Easing has on their own (original) definition not appeared to have done much to help the UK economy but the way asset price bubbles have risen it would appear that it has contributed to a rise in UK inflation. It is not the first time in UK economic history that a monetary policy has had a monetary rather than a real economy response.

Should this rise in inflation prove to continue then we are giving ourselves a problem. One of the ways the UK economy could improve over the next year is to take advantage of the drop in our exchange rate since 2007 and export more and import less. However export-led growth is less likely if we allow ourselves to fritter away the competitive advantage gained from this depreciation by having higher inflation than our peers. These inflation figures are 2% higher than the most recent figures for the euro zone which were 1.4% for February.

Even these much lower figures of 1.4% for the Euro zone disturbed Jurgen Stark who is an executive board member of the European Central Bank who said in a speech last week according to the FT that inflation risks “seem to be tilted to the upside”. He followed this up with

“A multi speed recovery of the world economy, with some regions growing fast, while the recovery in others remains rather slow, has the potential to exert upward pressure on prices. In the same vein, we also need to monitor very closely the possible adverse impact from fiscal developments on the inflation outlook.”

Imagine what he would be saying if Euro zone inflation was at our levels…

My question to our Monetary Policy Committee is how long is a temporary blip?

Technical Point

I felt that when the inflation targeting system was changed in the UK it was a policy error and I feel that this years figures are confirming this. When it was changed I argued that there were two main flaws.

1. The gap between the new and old target should have been more like 0.75% rather than 0.5%

2. There is a difference in the standard deviation of the two measures with RPIX being likely to have a higher measure on this than CPI. In other words for the same rise (fall) in inflation we are likely to see a bigger move in RPI than CPI.

Unfortunately I was only one voice but this years numbers are reinforcing my original criticisms of the change. Our current inflation measure is 1.4% over target and our previous measure is 2.3% over target. Seeing as they are supposed to be measuring the same concept this is quite a difference!

10 thoughts on “UK Inflation problems persist and Greece's poker style gamble”

  1. andy of yarm says:

    We should have followed the Australian example and eased rates upwards earlier in the year.This would have sent a clear sgnal to the market of an intention to keep asset prices as stable as possible.

    Instead we want to ‘look through’ (ignore) inflationary pressures.The problem the magnitude of rates increases that will be required in the coming years to subdue these pressures is more than the nations indebtness could bear.

    The MPC should be ashamed of themselves.

  2. Drf says:

    “These are poor figures and to my mind they call into question the credibility of the Monetary Policy Committee.” Surely, it is not just the `credibility” of the MPC which is in question, but the individual competence of the members? As you have touched on, they have failed in their sole remit now for over 1 year. In any other job that would by now mean – the sack ! The difference here is of course that they are all hand-picked by Brown.

    Then again, there is the question of the reliability of the government inflation statistics. One has to remember in this case that just prior to an election (obviously due to specific government instructions), the ONS changed the basket of items monitored. Now I cannot see any explanation for this other than a deliberate attempt to further manipulate the numbers downwards. Nevertheless, it is clear that their efforts have failed and inflation has risen sharply again, with a continuing upwards trend line.

    Surely if KIng were a competent BoE govenor he would pretty quickly now raise base rate. As Andy observes, if this is not done immediately then much higher rises will be needed later to get inflation back under control.

    Finally, what still completely puzzles me is how under these conditions the government is evidently still managing to sell its Gilts in the market at current rates? With the present continuing inflation rising trend, buyers will be losing their purchasing power ! Who is there, apart from the conscripted few, under these conditions of potential loss, that would buy?

  3. Carys says:

    Rates cannot be raised before the election. Afterwards we will see rises, however much Labour may wish to prevent them. My guess at the moment is that they will reach 5% in 18 months time, to the accompaniment of howls of anguish from the housing mafia.
    Inflation is absolutely inevitable on imported goods (which are often also part of UK made products) because we have seen a very large devaluation and the pipeline of goods at predevaluation prices is now empty. QE was designed to forestall deflation/create inflation and an increasing oil price paid in dollars is just another problem.
    Most of the pronouncements by government at this point are pure propaganda, designed to smooth over huge economic problems before the vote. Whoever wins (if anyone does) there will be a big reversion to reality starting on May 7th. The shortest honeymoon ever! The first thing will be big wage demands from the public sector, then the rating agencies will start to get restless…

  4. jacqui says:

    I have been trying to understand inflation and deflation. one theory I have found explains it thus:
    Inflation = an abundance of money
    Deflation = a shortage of money
    The government have attempted to increase money supply and stimulate spending via QE, but there is no capacity to take on further debt (money is borrowed into the economy), so the velocity of money has fallen, also the risks of default by customers leads banks to charge higher interest rates (eg. credit cards)., This also means that “investment” money is flowing into the stock markets including commodities which is causing the price inflation we are seeing (along with depreciation of our currency). Also banks may see Gilts as a safer way to earn income (lower risk than consumers).
    Just a few ideas I have found online, interested to hear of their validity.
    Thanks Jacqui

  5. max says:

    Great blog. What do you see as the effect on the Housing market recovery, which in London stands at above peak 2007 levels? Will inflation inflate prices more, or will high mortgage rates depress demand?

    1. Hi Max and wellcome

      The London property market looks like it is what economics text books call an exogenous shock to me. That is that the fall in sterling has made the market look cheap to foreign buyers (particularly Europeans as far as I can gather). With the 25% fall in sterling has come low volumes in terms of actual domestic buying and selling and so this foreign buying has been enough to put prices back to their highs in central London. So I feel that for now it is a bubble with low volumes because if we had a more normal level of house sales it would have had less of an influence . Perhaps we will see some more volume this spring and I hope so as the current situation is unhealthy and misleading…

  6. sokin says:

    3 month Tbills tax free 3.65%

  7. Mr.Kowalski says:

    Zerohedge has an article in which a rumored bankruptcy with creditors taking a 25% or so haircut.. not sure where these are coming from.. even then, would it be enough ? I know you said 15%; my own hunch is that something closer to 50% would be needed to clear Greece for the next few years

    1. Hi Mr.Kowalski
      I was hoping that a rational solution could be built up where everybody gave a little ground. My logic was that if Greece cut her debts by 15% in effect she would be going backwards in time a year. Then she would have a year for her austerity plan to begin to take effect. Europe and the IMF could help with aid as they had promised and her borrowing costs could come down. So once the year was over she would be in a lot better shape than now and everybody could help and also give a little ground. Instead of course we have seen dithering and grandstanding. We are also seeing evidence that the austerity programme may not be all it is promised…

      Also 15% is probably affordable for those who have loaned to Greece. There is the danger of contagion here where other nations banks are taken down by this…

      Before this is over we will get plenty of rumours. Friday afternoons in the City of London had loads of the UK joining the ERM Friday afternoon rumours and ironically when it happened I missed it as I was working in Tokyo!

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