Hamish McRae: The grand Old Lady marched rates to the top of the hill, and it will march them down again

Click to follow
The Independent Online

Inflation is a puzzle these days. On one hand, the price of homes has risen by something close to 20 per cent over the past year, and the price of oil by more than that. Council tax charges have risen in the high single figures and train fares have done much the same. On the other hand, cars, clothing, phone calls, air fares and electronic kit are all cheaper than they were a year ago and much cheaper than five years ago. The figure we read about for consumer inflation - a bit under 2 per cent a year - doesn't square with our experience. Maybe on average the figure is right, but who is average these days?

Inflation is a puzzle these days. On one hand, the price of homes has risen by something close to 20 per cent over the past year, and the price of oil by more than that. Council tax charges have risen in the high single figures and train fares have done much the same. On the other hand, cars, clothing, phone calls, air fares and electronic kit are all cheaper than they were a year ago and much cheaper than five years ago. The figure we read about for consumer inflation - a bit under 2 per cent a year - doesn't square with our experience. Maybe on average the figure is right, but who is average these days?

If this is a puzzle for us, the experts are evidently confused too. The Bank of England's commentary on its interest rate decisions in its latest Inflation Report seems to justify the recent upward moves in rates largely on the grounds that the economy is growing strongly and people are taking on too much debt. But the Bank is supposed to set rates to control inflation, not to control the economy or our eagerness to borrow. And inflation has been consistently below target on both measures, the old retail price index and the new consumer price one. It does suggest that in 2006 inflation might rise to the target 2 per cent if rates are not changed, but that is what it is supposed to be aiming at. So what it really seems to be doing is taking an overall decision on the stability of the economy and fitting its policy to that.

At any rate, you can see from the first graph the extreme divergence between inflation in the service sector and in goods. Services inflation has been remarkably steady at around 3 to 4 per cent, while that for goods has gone from 2 per cent at the start of 1997, to minus 5 per cent in 2002 and back to minus 1.5 per cent today. It is very hard, looking at that graph, to see much of a case for raising rates simply to curb inflation for there is very little of it.

This leads to a further thought. The Bank's latest report seemed less concerned about inflation than the previous one, leading to suggestions that the peak in rates may be 5 to 5.25 per cent next spring, rather than the 5.5 per cent many economists seem to expect next summer. But that would only happen were the housing boom to snuff itself out in the meantime.

The report presents its expectations for the economy is a new way. Instead of assuming unchanged rates, it emphasises the interest rates predicted by the market. On this basis, growth is expected to continue above trend, running at about 4 per cent during the second half of this year, slowing a bit next year and then eventually picking up in 2007.

I don't think we should take any projections for growth in 2005 too seriously, let alone 2006 or 2007. All the experience of such medium-term forecasts is that they will be wrong. The only thing you can say is that, in the case of the US and UK, these forecasts have tended to underestimate growth; in the euro area, they have tended to overestimate it.

It is worth, though, asking some questions, the most obvious of which is whether growth, or rather lack of it, might now become a bigger danger than inflation.

The usual internal force pushing up inflation is the labour market. But although unemployment, on the claimant count measure, is at a 30-year low, if you look at the right- hand graph then private sector wage growth (excluding bonuses) has been very muted. Public sector wages have been under upward pressure recently but we are promised by the Chancellor that the hiring policy will be more circumspect in future. (In fact, we are promised he will lose nearly 100,000 civil service posts, though I would not take that too seriously.)

So there really is not much internal inflationary pressure. External pressure? The only sensible assumption would be that the price of imported goods will continue to fall, as low-wage countries enlarge their share of export markets, while the price of energy will stay high. But while expensive energy does of course have an impact on inflation, it also sucks out demand. Here, the Bank notes that there are three threats next year: a fall in house prices, a rise in oil prices and a fall in external demand. In the view of GFC Economics, a consultancy in London with a good record on calling turning points, these dangers are sufficiently important to warrant caution on rates. Even if they do rise to 5 to 5.25 per cent next spring, they will come down faster than the market expects.

What might this mean for the rest of us? Several things. One would be that if house prices come off sharply, expect rates to be cut. Another would be that we really shouldn't worry about inflation. My own feeling is that we might see an upward blip in the next couple of years but we are in a world where prices are as likely to fall as to rise.

Another implication would be that the spectre of yet more expensive oil is a threat to output rather than inflation. It takes demand out of the world economy. In one sense the UK is less affected than other large economies for we are still, just, a net exporter of oil. But we would feel the chill in export markets, particularly on the Continent.

And a final implication, from a British perspective, would be that if people can stay in their jobs, they can ride out a fall in house prices in a way they could not have done in the early 1990s when soaring rates squeezed the whole economy. Employment has been very strong, rising steadily in the UK since 1992. The very latest figures, out last week, were a little ambiguous for there seemed to be some slight fall-off this spring and a lot of the new jobs are self-employed ones. But firms are positive about their hiring plans so it is too early to worry about that.

So, if the labour market stays strong, all will be well. All the worries about a housing crash and consumers taking on too much debt are real enough, though we would be able to earn our way out of trouble. But looking at the balance of difficulties ahead, there is some risk to growth. If it starts to falter next year, expect rates to fall. The message is that just as the UK led rates upwards, so it may lead them back down.

Commuters are stuck in the Stone Age

Been stuck in a motorway jam this weekend? Spent too much time in the airport? Or just facing the usual commuting drag?

Well, in a sense, 'twas ever thus. An article by Dr David Metz in the journal of the Royal Academy of Engineering suggests that on average we spend an hour a day on the move. Not only have we done that for the past 30 years here in Britain, we did it a century ago, before the spread of the car. We did it before the invention of the railways. And we apparently did it going right back to the Stone Age.

Travel time has always governed the size of human communities, so it has always been roughly the same. In early Greek settlements, it took about half an hour to walk from the centre to the outer limits. And so it was in ancient cities, which grew inefficient if people had to travel much longer than 30 minutes.

That was in Roman times. Much later, the railways and the motor car made urban sprawls possible. We spent the same amount of time travelling but simply travelled further. London, like all large cities, is at the outer limits of efficiency, with an average commuting time of around 45 to 50 minutes.

The numbers of journeys, too, have not changed much, at least in recent times. On average we make about 1,000 trips a year. And finally people spend about the same proportion of their income on travel - the key variable being whether they have a car or not. Families around the world without cars spend 3 to 5 per cent of their income on travel, while those with spend 10 to 15 per cent. (In Britain it is about 16 per cent.)

So what happens next? Technology will continue to advance and we hope that incomes will continue to rise. So will we simply travel further and further but always spend the same amount of time travelling? Will more and more money go into roads, airports and urban transport systems, and we will just mop up whatever additional mobility we are offered?

Dr Metz has a suggestion. It is that instead of trying to cut travel times - which would be self-defeating - we should try to make travel more pleasant and more comfortable. We would still strive to satisfy our thirst for mobility but enjoy the experience more. Tell that to Ryanair and Ken Livingstone.

Comments