Sean O'Grady: What's that coming over the hill?

Economic Studies
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Inflation, and lots of it. We know about Vat going up to 20 per cent on 4 January, but it's what's going to come after that should really worry us, for a depressed economy is no barrier to rising prices, as we will shortly see.

Global commodity prices are spiralling out of sight once again; the $100 barrel of oil will return before January is out. Cotton is up 30 per cent since September, and corn by 35 per cent, for example. Some crop prices are back to the levels set in the food crisis of 2008; freakish weather conditions such as the drought and failure of the Russian wheat harvest will have long-lasting effects, and beyond that there is a resurgence in demand from China, which is bidding up the price of industrial materials and crops for western buyers.

Quite why Chinese demand for corn has risen 3,000 per cent in a year I do not know, but there it is, one sign of how income and wealth is being steadily redistributed eastwards, as the buying muscle of China commands a growing share of the earth's bounty at the West's expense. (The Christmas Day hike in interest rates in China confirms that inflationary worries are growing over there too.)

Our public spending cuts will, in their own insidious way, also add to the inflationary pressures. This will include the trivial – car parking charges ramped skywards by desperate local authorities – to the highly material, such as dwindling subsidies for public transport and steep rises in commuter rail fares. And soon enough, there will be a 300 per cent rise in tuition fees for some. Meanwhile, the £6 gallon of petrol (£1.50 a litre) cannot be far away. Gas and electricity prices will see more eye-watering rises in 2011, on the back of record demand from the cold weather, here and now in North America. The list goes on.

That, then, will be the first round of inflation – and notice how it is concentrated on the basics of life – fuel, energy, food, clothing, public transport; stuff we cannot avoid spending our cash on. How big the second round of inflation proves to be depends on how workers respond as they fill up the car, do the shopping, pay the gas bill and buy their season tickets. The fact that DVDs or used cars are getting cheaper is not much comfort when unavoidable living costs are rocketing.

Will we demand more pay? So far, the willingness of employees to forgo wage rises in the interests of preserving jobs has been one of the more remarkable aspects of the downturn, and it has helped to minimise the rise in unemployment. Never before, not even in the 1930s, have British workers shown such flexibility. What has been the case in the private sector is now being applied to the public sector, with a freeze on salaries over £21,000. I suspect that pay restraint will be much more difficult to hold when inflation is above 3, 4 or 5 per cent (or more) than when it was negligible or negative, as for much of 2009.

If we're lucky, employers will absorb the rise in labour costs; if we're unlucky we might see jobs lost or attempts to pass on the rise in wage costs in higher prices, or both. Unlike those infernal 1970s Christmas pop hits from Wizzard and Mud, we haven't heard much about "cost push" inflation since that era, but the rise in global commodity prices and wage pressures does threaten to echo them.

Whether the Bank of England chooses to accommodate such behaviour will be crucial. Given that the signs of an old-fashioned wage-price spiral are still modest, and most of the rises I've been talking about are essentially temporary, the Bank should hold its nerve and interest rates, as it says it will.

It's basically too late to do anything about the inflation coming through now anyway. Inflation should slow naturally; oil, after all, cannot keep rising at 50 per cent a year, if only because it would tip the world into recession again, and drag the price back down with it, as in 2009; to that extent global commodity price trends are comfortingly self-regulating. At least half of our current inflation should simply drop out of the system in a year. Meantime we will be sitting on a very sharp inflationary spike. Only pensioners, who have their incomes inflation-proofed under government guarantee, can rest easy. Happy new year.

Beware the new year's VAT scam

A tip for the sales: when you see the slogan "we pay the VAT", reach for your wallet – to protect it rather than open it. I've no proof of motive, but there is strong circumstantial evidence that some retailers quietly pushed their prices higher in November just so that they can say to their customers now that they will pay the extra VAT or are holding their prices steady after the tax hike, or some such apparently generous offer.

The official Consumer Price Index data showed quite marked, and unusual, rises in the prices of furniture and consumer goods a few weeks ago – typical new year sales purchases – and it just made me a little suspicious (notwithstanding the generally high inflation pressures around). So far as I can see, retailers using this tactic can handily evade the various rules regarding what constitutes a "sale price".

Paranoid? As it happens, I was mooching round a couple of well-known department stores a few weeks ago in search of bed linen, which was in curiously short supply. One shop assistant told me that they had none in stock, but that they would get some in "in time for the sales", when they would be reduced, naturally. Reduced from what, though? I'm still trying to work that one out.