Drink and be sorry

By Buttonwood

THE latest UK inflation measure shows the extent of the problem. The headline measure, the consumer price index, is at 4%, double the government's target. In the old days, the Bank of England used to target RPIX (the retail price index minus mortgage payments) and that rose to 5.1% (given that mortgage rates were unchanged in 2010, the standard RPI is up by the same amount). One could argue that the performance is even worse on this measure, since the standard gap between CPI and RPI is 0.85 percentage points (the RPIX target used to be 2.5%).

The VAT rise from 17.5% to 20% seems to have been passed on pretty quickly (unlike the situation last year, when a temporary VAT cut was reversed). Alcoholic drinks were an important driver of the increase (so feel doubly virtuous if you went on a detox diet last month) but restaurants also played their part (my Starbucks was quick off the mark in pushing up the price of a latte to £2.50). And of course there was oil.

Now the RPI figure may have some flaws, as one of my colleagues has argued. It certainly seems to produce some odd results for clothing. But it is pretty clear that the UK is suffering a worse inflation performance than its European competitors.

The effect is a cut in the real British standard of living; wages are rising by only 2.3% a year. Now to the extent that this is part of a process of reorienting the economy towards an export-led model, it might be a "price worth paying". Sterling's fall (back in 2008) pushed domesitc prices higher but made exporters more competitive; some countries in the euro-zone might long for this trade-off.

The trouble is that the UK hasn't seen the required trade improvement. The deficit on goods and services was £46.2 billion in 2010, up from £29.7 billion in the previous year.

One has to feel sorry for the Bank of England. It keeps missing the inflation target and risks losing its credibility but the VAT rise and higher oil prices are not under its control. It would be tough to raise rates after figures showing the UK economy contracted in the fourth quarter of 2010. There may be a broader lesson for investors to learn; they are acting as if central banks can revive the global economy with monetary policy, whilst keeping inflation low. But banks are not masters of the universe; sometimes, as the Bank of England shows, they can be helpless passengers of events.