29 June 2022

Why the UK is in a race to outrun persistent inflation

Those enjoying strawberries and cream beneath their plastic ponchos at Wimbledon this year may be unaware that they are taking part in an act of economic nostalgia. The cost of producing strawberries has risen by 80 per cent in the past two years, but at Wimbledon they will be sold for £2.50 a punnet – the same price as they were in 2010. Sally Bolton, the chief executive of the All England Lawn Tennis Club, told the Evening Standard this week that “like every other business our costs are increasing across the board” but “as much as we can, we’re trying not to pass that on to the consumer”.

Andrew Bailey, the governor of the Bank of England, could be accused of taking a similarly rose-tinted approach to inflation. The Bank’s most recent decision on interest rates was a relatively modest 0.25 per cent rise, while in the US the Federal Reserve hiked its base rate by three times that amount. Rising rates can be painful for businesses and consumers, because they push up borrowing costs, but one of the Bank’s economists, Catherine Mann, has warned that if the UK does not act more decisively, it risks falling behind other countries in its response to inflation, which could weaken the pound against other currencies, pushing prices higher still.

This is a risk because the factors behind the rising price of strawberries – and almost all other foods – are global. Russia’s war in Ukraine, and the sanctions imposed by other countries in response, introduced pressure on energy prices that had already been driven up by the global disruption of the pandemic. This in turn pushed up the cost of pretty much every area of commerce, from fertiliser to packaging, shipping, the wages of people who pick, pack and prepare strawberries and the systems that mean they are served at a temperature acceptable to the Wimbledon spectator.

On Monday (27 June), the Bank of International Settlements (BIS) warned that high inflation has “returned” as a global force, with three-quarters of economies currently experiencing inflation above 5 per cent. “Inflation [is] back, not as a long-sought friend, but as a threatening foe,” it wrote, rather poetically. It called on central banks to do everything in their power to control that inflation, lest it become entrenched. Persistent inflation would be “structurally conducive to wage-price spirals”, it warned: if prices rise for long enough, wages will try to meet them, and businesses will charge more to meet the cost of their higher wage bills, and so on. Stagflation – where inflation is high but economic growth is low – “looms”.

The BIS is known as the “central banks’ central bank” because it is responsible for providing banking services to the world’s central banks. Based in Switzerland, it has sometimes had a difficult time reconciling its hands-off focus on financial stability with the geopolitics of the countries it serves; most controversially, it continued to provide banking services to the German Reichsbank during the Second World War. In March, however, it suspended the Russian central bank’s access to services following Western sanctions, helping to cut Russia off from the wider global economy.

In this week’s report, the BIS called for “timely and decisive” action by central banks, insisting they start raising interest rates swiftly. An economic shock is now all but certain, it said – but if central banks get it right, they may be able to engineer a so-called “soft landing”, in which economic growth slows just a little, rather than the alternative option, which is entering a full-blown global recession.

A box near the bottom of the report assessed the conditions whereby a soft landing is possible: “hard landings are more likely when monetary tightening is preceded by a build-up of financial vulnerabilities,” it wrote. “In particular, faster growth in credit relative to GDP prior to a tightening episode is associated with hard landings… heightened vulnerabilities mean that a growth slowdown is more likely to trigger a recession.” In the UK, these financial vulnerabilities could include the fact that credit card borrowing reached the highest level since records began in February – and is expected to go higher as people borrow to pay for the rising prices of, for example, energy and bread.

The BIS report suggested that interest rates tend to climb about 1.4 percentage points during hard landings, compared with 0.8 for soft landings (in the UK, we’ve already had five rate rises, taking us from 0.25 per cent to 1.25 per cent), and inflation tends to be higher – 4.1 per cent, compared with 2.6 per cent for soft landings (ours was 7.5 per cent in December, at the beginning of this cycle of rate rises). The average change in GDP growth during these events is 3.8 percentage points.

All of which seems to indicate that we are in for months, if not years, of unpleasantness. At least we know we can rely on the price of Wimbledon strawberries. If that goes up, we’ll know we’re in trouble.