Accelerated Inflation signals a slow down in the UK Economy

Speaking in November 2007 following the US sub-prime mortgage crisis, Mervyn King the Governor of the Bank of England refused to describe the UK’s economic situation as ‘stagflation’ the dreaded blend of high inflation and recession.

At the time he did acknowledge that “compared with the very small movements we’ve seen in the last 10 years this looks like a very sharp slowdown”. It now looks as though this fear is indeed materializing. Current trends and forecasts indicate that the Banks delicate balancing act of managing the risks of inflation against those of economic slowdown as battle that it is seemingly loosing.

The Central Banks target 2 percent inflation rate is predicted to be closer to 2.6 percent, whilst the figure for economic expansion has been reduced by 0.6 percent from the October forecast according to the National Institute of Economic and Social Research (NIESR).

“The slowdown will be driven by the effects of the financial crisis in making the supply of credit scarcer and costlier for both households and businesses” said NIESR researchers Ray barrel and Ehsan Khoman, in their report ‘UK Economy Forecast’ published yesterday.

The performance in first quarter of 2008 is predicted to slip drastically whereby growth will drop below 0.4 percent. Other key indicators strongly hint towards an economic slowdown: a 2.1 percent reduction in consumer spending, housing investment down 1.3 percent, and business investment growth slipping by 3.2 percent.

The situation facing policy makers is whether to cut interest rates next week in order to fuel economic growth, despite the fear that inflation may reach its highest point in over a decade.

The NIESR report highlighted this catch-22 situation as it is argued that “monetary policy is not able to affect this near-term inflationary pressure much, but higher inflation would make a looser monetary policy more difficult to put in place”.

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