There are some serious rumblings going on in the city over the last month or so in relation to the Retail Price Index (RPI ) & Consumer Price Inflation (CPI ).
The Bank of England, which measures inflation and predicts the rates, have astoundingly got it wrong on 40 out of 49 months.
Targets Exceeded
Each time a target was set of 2% and it was exceeded. The RPI came in at 4.7% and the CPI unexpectedly rose to 3.3% in November 2010. This was up from 3.2% and largely due to food and clothing costs. It is is now expected to exceed 4% due to the Vat increase and commodity prices rising.
The question is this; Is this an irregular heart beat or something that will become a permanent trend?
If it does become a trend, there will be concerns over the credibility of the BoE which in turn may end up with the inflation believers to self fulfill the prophecy, thereby increasing inflation inadvertently, even though the BoE has tried to keep it down. The entail will increase the demand for higher wages so as to to keep up with inflation.In itself this will cause more headaches all round and further compounding the issues.
Current UK Growth Lower Than Inflation
With the UK growth currently lower than inflation, house prices falling, and consumer confidence waning, we can definitely expect to see rate rises. However the BoE cannot afford to increase rates yet to overcome inflation. Any Increase too soon will kill a fragile property market and the economy putting a huge strain on household income. Add t tha National Insurance, VAT hikes and other implicit tax hikes and you have a serious problem.
Overcoming Inflation-A Delicate Balance
When consumers start to feel low confidence they will either pull out of investments or place monies elsewhere. This hurts bank revenues, deposits and corporate taxes and could well pull us back into a recession. Time will only tell how long the BoE will be able to keep rates low. Pundits are already talking of a 1 to 1.5% increase in the BoE rate by the end of the year as a minimum. For investors, that means bond markets will probably recoil and we will re-enter a bear market. On the flip side, equities will do OK, however dividends will lose their appeal due to the rising costs and taxes in the investment company’s overheads.
Inflation: An Implicit Tax?
Questions also arise as to whether RPI and CPI rises are in effect inflation or an just an implicit Tax. Quantitative Easing, Chinese wages, commodity prices have all affected the CPI figures dramatically and the general public are now becoming concerned that money held on account is returning little. High inflation means the real value of money is actually decreasing in buying value, even without taking into account the taxation of savings.
Does QE Actually Work?
Wainwright, the economists, looked at monetary based growth, which is where QE is meant to impact most, and analysed data between 1950-2007 . They found that economy growth was actually higher when monetary growth was lower. This included industrial production and even stock market performances. What it does impact is prices. The CPI rose by an average of 5.1% in years of faster monetary growth, and just 2.8% in below average years. QE just expands claims on wealth not necessarily growth itself and beggars the question on whether it helps the economy at all.
Large Corporations Moving Abroad To Save Tax
The Government has recently seen large corporations uprooting and moving to lower tax havens or at least threatening to. Our large firm corporation tax is currently 28%, Ireland is 12.5%, Singapore 17% and Poland 19%. The exodus is already becoming apparent with pharmaceutical companies like Shire, Diageo and Unilever have all made noises about moving head offices to minimise the company tax burden. The government will potentially lose vast revenues in lost corporation tax and national Insurance. Currently only around 8% of total revenue is on corporation tax, so even doubling rates won’t actually make a dent in the deficit.
So, if investing, always pick investment sectors well and diversify the investments to counter any adverse cycles. Ensure that investment returns outperform inflation, and choose investments consistent with your risk attitude. Year end is looming- speak now or pay the tax for another year.
Article submitted by Simon Goody. Please contact us for more information.
