20th November 2008
News Category: Economics
Recent official figures show inflation fell sharply last month, following a sharp rise during the past year. The drop in the consumer prices index (CPI) dropped by 0.7%, meaning the current rate of inflation is 4.5%, still 2.5% higher above the Government set target of 2%. The Retail Price Index (RPI) (which takes into consideration the impact of the falling housing costs), also fell by 0.8%, reflecting the continued fall in property values. The Bank of England Money Policy Committee (MPC) had warned that a drop was imminent last month when it dramatically lowered base interest rates by a 1.5%. Minutes of the MPC meeting, revealed yesterday, reveal that its nine members even considered a drastic 2% cut in rates. Tim Beasley of the MPC, expects inflation to fall below the 2% target before the new year, as the UK slips into recession: "The Global price developments mean that inflation is likely to fall below target next year". The MPC faces a difficult challenge over the next year by lowering rates enough to help stimulate collapsing consumer demand and shattered business confidence. Falling demand may very likely reduce inflation well below the 2% level.
The drop in inflation was blamed on the near collapse of global crude oil prices as the energy markets reflected weaker demand in China, India and the USA. At the same time, UK property prices are continuing to fall with recent Land Registry figures showing an annual 15% drop. This fall is helping to compound downward inflationary pressure. Falling inflation is likely to reduce wage agreements which will have an adverse effect on consumer demand on the high street. High street shops fear this Christmas could be one of the worst trading years since the 1991 recession. The CBI also reported that manufacturing orders fell for a fifth month in a row this month.
Reflecting the downward spiral on prices, many small and medium sized businesses are announcing poor financial results. Retail and services sector have been particularly hit as cash strapped families have tightened their belts and reined in unnecessary spending. To make matters worse for SME's, the global banking crisis continues to hit small businesses as the banks continue to reduce the number of small business loan approvals. The credit squeeze is putting intense pressure on small businesses as Banks impose larger overdraft charges.
Firms are also having cashflow problems as a result of an increases in late payment of invoices from large, more powerful suppliers. To make this cashflow problem potentially worse for small businesses, credit insurer, Atradius announced it was clawing back its cover provided to suppliers of tens of thousands of small businesses. This type of insurance covers businesses against the risk of non payment of invoices for products and services ordered on trade credit. As most larger suppliers demand trade credit, smaller suppliers without credit insurance, may be left with the real risk of business debts not being paid. Atradius expects more companies to enter into administration next year and is reducing its potential loses in this market, by reducing its exposure to £25 billion of risk.
To resolve these inflationary and economic issues, the Prime Minister recently took a leading role at the G20 meeting, to agree a coherent financial strategy to deal with the prolonged economic crisis. In the UK, the Government has stated it plans to increase or bring forward public spending plans to help stimulate economic output, to counter an economic slowdown. The IMF recently called on the UK Government to reduce consumer taxes to stimulate consumer spending to counter deflation. The IMF calculates that income tax should be reduced by £2000 per person to achieves this aim. Unfortunately, Government debt is already 55% of GDP, (including the cost of the Northern Rock nationalisation). The Conservatives are now arguing that continued Government borrowing, risks devaluing sterling, as other countries view our indebted nation with increasing concern. The pound has already fallen by 30% in the last 6 months making UK exporters goods and services less competitive. The Tories argue that lower taxes should only be funded by lower public spending (as opposed to simply increasing Government borrowing). It argues that more Government borrowing today will lead to big tax increases in future.
With a global economic recession, a continuing credit squeeze, falling UK property market,, fluctuating energy prices and a general election within 18 months - the MPC clearly faces a tough challenge of managing inflation with interest rates alone.