Tuesday, December 12, 2006

U.K. Price Inflation Reaches New High

U.K. consumer price inflation according to the EU-harmonized definition rose to 2.7% in November from 2.4% in October, the highest ever during the EU-harmonized index have been in place in Britain (i.e. since January 1997). Another index, the Retail Price index showed even higher inflation (3.9%).

Ironically, this increse in domestic price inflation in Britain (i.e. the erosion of the pound's domestic purchasing power) could at least in the short term increase its external purchasing power. The reason is that foreign exchange rates today are in the short term mainly determined by movements in nominal interest rates. And as inflation is now far above the Bank of England's targets, this makes further interest rate increases increasingly likely. And indeed, so was the case today as the pound surged against both the euro and the dollar.

Incidentally, Swedish price inflation also accelerated, although it is still below the Riksbank's 2% target. But as excessive Swedish money supply growth causes other imbalances, more interest rate hikes will be needed in Sweden too.


Blogger Flavian said...


7:11 PM  
Blogger Flavian said...

The fact that inflationary tendencies make tighter monetary policies necessary may ver well as you point out drive the excahnge rate upwards temporarily.

That might make inflation seem lower than it really is. One year ago the price of one Big Mac in the UK was £1,88. Today the price is £1,99 or an increase of nearly 5,9%.

In 1974 the price of one Big Mac in the UK was £0,45. If the price would still have been £0,45 and relative prices had changed identically to what is actually the case, the 2006 CPI would still be 40-45% higher than the 1974 CPI.

That indicates that the relative price of a Big Mac is dropping gradually and it also indicates that the British inflation rate is in reality even higher than 5,9%.

This is the problem in a nutshell: High inflation requires tight money and expectations about tight money make the real excahnge rate climb with the result that the conventional CPI sometimes under-estimates the "true" inflation rate very much.

However the Big Mac seems to give much more adequate information about the "true" inflation rate.

7:20 PM  
Blogger Flavian said...

Another tragic example of modern British inflationism is that the price of one copy of the Economist was 8½d. for decades prior to WW1. After WW1 the price was raised to 1s., in the 1950:s the price was raised to 1s.6d., in the 1960 the price was raised first to 2s. and then to 2s.6d. In 1970 the price was raised two times. The first time from 2s.6d. to 3s. and the second time to 4s. In 1979 the price had risen to £0,60 or 12 shillings. In 1989 the price was £1,50 or 30 shillings and the last time I checked it the price in Gibraltar was £3,10 or 62 shillings! (The Gibraltar pound is at par with sterling.)

Now if Britain has lost it's role as the world's leading industrial nation it is certainly not related to any lack of £/s/d!

9:57 PM  

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