“This week’s fresh batch of UK inflation numbers will be an important test for the Bank of England’s monetary policy and its argument that the current burst in inflation will be short-lived, not least because higher inflation is already eating into consumer confidence, and perhaps faith in the Federal Reserve’s policies in the USA,” says AJ Bell investment director Russ Mould. “Just as inflation has hit a 31-year high Stateside, consumer confidence has slumped to a 10-year low (despite booming house and share prices) and financial markets have started to latch on to this trend by warming to gold, which trades at five-month highs.
Source: FRED – St. Louis Federal Reserve database
“According to the GfK survey on this side of the Pond, consumer confidence is also weakening, perhaps as higher fuel and energy and food prices take their toll. If inflation does not tamp down, then consumers really could start to feel the pinch, especially as the 1.25% increase in National Insurance contributions is due to come into force in April 2022. Yes, wages are rising but if inflation keeps pace (or runs faster) then ultimately no-one is better off in real terms. Increases in the rate of inflation clearly knocked consumer confidence in the late 1970s, late 1980s and even 2009-10, especially as sharply higher interest rates followed in the first two instances, increasing the cost of mortgages, car and bank loans.
Source: GfK, Office for National Statistics, Refinitiv data
“Central banks therefore face a difficult balancing act. The US Federal Reserve has a dual mandate, to preserve price stability and get as close to full employment as possible. The Bank of England’s only official task is to keep inflation around 2% but the Monetary Policy Committee is citing concerns over the labour market for its decision to keep interest rates at a record low of 0.1% - even if the UK economy is forecast to grow by 6% or more in 2021 and 2022, unemployment is down to 4.5% and wage growth is running at 6% to 8%, excluding or including bonuses (even if the real, underlying rate of progress is less than that owing to base effects caused by the pandemic and the furlough scheme).
“Normally, such figures would prompt much higher interest rates, but fear of unemployment seems to be running more strongly than fear of inflation in both Threadneedle Street and the Marriner S. Eccles building.
“We have been here before.
- In the early 1970s, the Conservative Party’s then Chancellor of the Exchequer Tony Barber laid the foundations for the ‘Barber Boom’ in a dash for growth. (As it turned out Healey was later left with trying to pick up the pieces). On the other side of the Atlantic, the US Federal Reserve’s chair Arthur Burns acceded to pressure from the White House to run a loose monetary policy so that then President Richard M. Nixon could fund his welfare programmes and military campaigns in Vietnam. Burns even declared that America would not tolerate an unemployment rate of 6% as a means of holding inflation in check. Nixon relied on price and wage controls without success, although the oil price shock of 1973 in the wake of the Yom Kippur war hardly helped his cause. That well and truly lit up inflation, which then roared away for much of the 1970s, with a further bump coming at the end of the decade when oil prices spiked again, this time because of the 1979 Iranian Revolution.
Source: Office for National Statistics
- That inflation, and public discontent with their economic lot, saw the Labour Party under James Callaghan and the American Democrats under President Jimmy Carter both come a cropper. The former fell to the Conservatives’ Margaret Thatcher in 1979, the latter to the Republicans’ Ronald Reagan in 1980 and, aided by Paul Volcker at the US Federal Reserve, they ushered in a new orthodoxy. Fiscal policy and inflation were out, monetary policy was in and unemployment was the price to be temporarily paid.
Source: FRED – St. Louis Federal Reserve database
- That viewpoint has prevailed consistently until 2007 when a housing, financial market and debt bubble almost blew up the economy. Since then, central bankers have been trying to stoke inflation, almost singularly without success until the economic downturn that followed the pandemic and lockdowns in 2020.
“Investors are watching the Fed and Bank and England walk this tightrope and possibly with growing unease. The apparent calculation to risk higher inflation in return for lower unemployment could yet lead to complications should price rises and increases in the cost of living prove higher for longer than the central banks expect.
“As an investment gold thrived in the 1970s, as inflation ran rampant, surging from $35 an ounce to $835 an ounce in a decade. Yet it did nothing for two decades, despite some inflationary spikes, and that may have been because central banks (or in the UK’s case for some of the time the Chancellor of the Exchequer) were implacable in their view that inflation was the ultimate enemy.
“That does not seem to be the case right now and if consumers and markets alike start to lose faith in the central bank narrative that inflation is temporary and the fault of post-pandemic bottlenecks and supply side disruption, rather than excessively loose and stimulative policy during an economic recovery, then gold could start to come into its own again – even if this time it is starting from around $1,860 an ounce rather than $35. It is noticeable how spikes in inflation have coincided with dips in consumer confidence which have in turn coincided with gains in gold.”
Source: GfK, Refinitiv data
Source: FRED – St. Louis Federal Reserve, Refinitiv data
