Inflation below 2% next year. From the comments of Bank of England governor Mervyn King, it's a racing certainty. The 9-0 vote for more quantitative easing would appear to show that other members of the monetary policy committee think the same way.
Yet there appear to be two contradictory trends working against a sharp fall in inflation, at least a fall that takes inflation down to 2% or below.
The first is the onset of, in Moody's words, a mild recession for the UK. While this will dampen demand, and calm inflationary pressures, it will also send sterling downwards. Much of the UK's inflation over the last two years follows a 25% drop in sterling's value and the consequent rise in import prices. A drop from today's $1.61 to the pound to below $1.50 could halt the projected slowdown in price growth.
Third-quarter GDP tomorrow may show the economy flatlining rather than contracting, but nonetheless, Moody's and others expect a second recession in three years.
Then there is analysis by Simon Ward, at Henderson Investors. He says the MPC has misunderstood the effects of QE, which was offset in 2009 by de-leveraging in the banking and corporate sector. Now they are in better shape, there could be a doubling effect that pushes up the money supply and adds to inflationary pressures.
He says: "Planned QE2 gilt purchases of £75bn are equivalent to 3.7% of broad liquidity. QE1 did not result in faster monetary expansion because of a simultaneous effort by companies to repay bank debt and banks to raise capital.
"With corporate and bank finances much stronger than in 2009, QE2 is likely to suffer less 'leakage'.
"Liquidity growth, therefore, could plausibly rise to more than 5% annually by early 2012 – inconsistent with achievement of the 2% inflation target over the medium term, assuming that nominal GDP continues to outpace money."
Ward believes inflation is eating into living standards and preventing an upturn, when it seems more plausible that the effects of overhanging debts, in the UK and eurozone, are hindering the recovery.
So as Martin Weale, a supporter of tighter monetary policy earlier this year, has said on the balance of risks, creating a bit of inflation through monetary easing poses a lesser risk to the long-term health of the economy and projections of low and stable inflation than simply doing nothing and letting the economy sort itself out.
