We believe that inflation is now far more serious than most commentators suggest, since the current rate is heavily flattered by a one-off factor - the recent rise in sterling. Our UK economic model recently calculated the impact, on current UK inflation, of the near 25 per cent rise in sterling since last summer. Based on the proportion of total UK input costs represented by imports, we estimate that the 3 per cent inflation rate for the 12 months to July 1997 would have been at least 2.5 per cent higher if sterling had remained static over the last 12 months. In other words, the fundamental (sterling adjusted) inflation rate is around 5.5 per cent.
The inflationary pressures come home to roost in 1998. It is likely that, between now and next summer, there will be no significant net rise in sterling. For the Treasury to hit its inflation target of around 2.5 per cent in the 12 months to July 1998, the Bank of England will have to take further action to rein in consumer spending. This must involve still higher interest rates.
M C FITZPATRICK
Head of Economics
London WC1Reuse content