In These New Times

A new paradigm for a post-imperial world

Fears for UK growth as inflation sabotages austerity

Posted by seumasach on February 14, 2011

The UK economy is a chamber of horrors with scary encounters with the spectres of inflation, unemployment, bankruptcy and, horror of horrors, the unmentionable run on the pound.


14th February, 2011

Traders have warned that inflation is undermining the work done by the Coalition’s austerity measures to keep interest rates under control. The yield on 10-year gilts has jumped half a percentage point since the start of the year and a whole percentage point since September to 3.87pc, escalating the cost of raising new Government debt.

Justin Knight, head of European rate strategy at UBS, said: “What has been driving UK yields is the prospect or risk of inflation, which has to be priced in. There are distinct concerns about inflation.”

Official data for January, released on Tuesday, is expected to show inflation has soared above 4pc – more than twice the Bank of England’s target level and the highest rate since 2008. The figure, which follows a shock rise in the December rate to 3.7pc, will bounce Mervyn King, the Bank’s Governor, into writing a fifth successive letter of explanation to the Chancellor.

According to the Office for Budget Responsibility, a one percentage point increase in gilt yields will add £15bn to the cost of financing the public debt over the next five years – equivalent to 11pc of the total austerity measures. In 2015 alone, the cost would be £68.4bn against current forecasts of £63.1bn.

The OBR made the forecast in its November update, after yields had fallen dramatically on renewed confidence in the Government’s plans to deal with the public finances.

UK inflation is running at almost twice the rate as that on both the Continent and the US, as the weak pound has pushed up the cost of imports. A spike in global commodity prices, for oil and food in particular, has also fuelled price growth, as well as the VAT rise from 17.5pc to 20pc.

Despite soaring inflation, the Bank has left rates unchanged at their record low of 0.5pc for two full years. The Bank will explain its policy on Wednesday in its quarterly Inflation Report. The Governor has long argued that, excluding imported and one-off cost pressures, “inflation is close to zero and well below target”.

However, markets have already begun to de-couple from central bank policy, with sterling rate futures pricing in a first move in May and a total 0.75 percentage point rise by the end of the year.

The Bank is also expected to lower its growth forecasts for the UK this year, from 2.6pc to about 2pc, rekindling “stagflation” fears of slow growth and high inflation that will further squeeze household finances.

Market rates on 10-year government debt have been rising across the world, but traders said the changes relate to different domestic problems. In Germany, which has tracked the UK rise, traders are more concerned about the cost of a European bail-out. In the US, bond markets are pricing in recovery. The inflation fear is unique to the UK.

Inflation concerns were stoked further by a survey today from Lloyds TSB that found “the rate of inflation in each English region was the strongest since at least September 2008”.



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