Inflation Hits Target But It's Far From Rosy For The UK

It should have been good news yesterday. UK CPI inflation has finally hit the Bank of England’s 2 percent target in December after four years of difficulty.

That’s four years of open letters from successive BoE governors to the Chancellor for every month that inflation is off target by more than 1 percentage point, spelling out their plan on how they intend to get back on course.

Yesterday’s 2 percent result might save Mark Carney a postage stamp to George Osborne, but it’s far from rosy.

Firstly, interest rates are at record lows. For long-term savers, interest rates hit 2.4 percent in November, according to data compiled by discretionary fund manager Nutmeg.

Nutmeg’s chief executive Nick Hungerford said: “We’re on the road to economic recovery, but it’ll still be a long time until households feel the benefit in real terms and this is particularly true for savers, who are also faced with the prospect of low interest rates throughout 2014.”

In addition, there are rising energy prices to contend with - house prices are rising more rapidly than average earnings, which remain below pre-crisis levels, and household debt is also on the rise.

Jason Hollands, managing director of business development and communications at wealth manager Bestinvest, said that the UK’s real economic picture is more fragile than bullish headlines would suggest.

“The slew of positive economic data over the last 12 months has benefitted from the tailwinds of the last round of UK QE [quantitative easing] in 2012, ongoing highly accommodative interest rates and, let’s not forget, the temporary benefit for more than £12 billion of PPI [payment protection insurance] claims being injected into the economy,” he said.

It may seem surprising that inflation has decreased from 2.1 percent in November, since the UK has printed a whopping £375 billion in total as part of its quantitative easing programme, which many expected to have an inflationary effect.

So where has all the money gone? Paul Sedgwick, head of investments at Frank Investments, suggested the banks were keeping this liquidity out of reach, and not being used to help prevent the economy from stagnating. This adds to the UK's lack of wage inflation.

“More needs to be done to set the funds free, to get it where it’s needed and not be trapped within the banking system,” he said.

This is where Mark Carney’s forward guidance comes in. The BoE has stipulated countless times that it will not consider rising interest rates until unemployment comes down to 7 percent, just 0.4 percent down from its current level. But will yesterday’s inflation result change the BoE’s mind?

Hollands said: “The Bank of England has been at pains to communicate a dovish message but the markets are increasingly factoring in a rate rise over the next year while reportedly mortgage lenders are stress testing applicants.”

The fact is that even a modest rise in interest rates could prove painful, especially for those who have entered the property market, and particularly those who consider our present ultra-low interest rates as the “norm”.

I hate to be the bearer of bad news. But hitting the inflation target is just the silver lining of a blacker cloud surrounding the health of the UK economy.