Higher Interest Rates Could Cause More Inflation

Back in April I predicted the Bank of England wouldn’t cut interest rates. I expected they’d recognise inflation as the real threat, and try to stamp it out.

I was wrong. The Bank cut the rate in April.

The next day, April 11, I expressed my disappointment in this e-letter. I closed with the following paragraph:

Of course, it’s easy to sit on the sidelines and carp. The MPC had a very tricky call to make yesterday. But by straying from its core objective, it has ensured its credibility has taken a hit. That’s likely to mean even trickier decisions in the months ahead.

Now the Bank’s facing decisions that are more than tricky. They’re impossible.

The Bank’s Governor, Mervyn King, gave a speech at the Mansion House last night. He sought to strike a strong pose by hinting at a rise in interest rates:

"There should be no doubt that the Monetary Policy Committee is prepared to take whatever action is needed to return inflation to the 2% target and to keep expectations of inflation in the medium term anchored to the target."

King hopes that by talking tough on inflation, it will show that the Bank means business. Inflation expectations will come back in line. Unions won’t lobby for excessive pay rises. The problem will just... go away.

Maybe the Bank won’t actually need to raise rates at all.

That’s the hope, anyway. But here’s where monetary policy might backfire. If you expect rates are about to rise, is this not an excellent reason to want more money in your wage packet — right now — to compensate for when your mortgage payments go up?

After all, you’re already paying through the nose for gas, electricity and the weekly shop.

If this mentality takes hold, the prospect of higher rates could itself drive up inflation. That’s not what the theory tells us — the theory says the cure to inflation is higher rates. But the real world has an annoying habit of refusing to conform to economists’ theories. This could be one of those times...

So the Bank’s stuck. Do nothing — and we probably get a wage-price spiral. Raise rates — same outcome.

This was probably inevitable. After all, prices are rising around the globe, not just in Britain. There’s a limit to what one nation’s policy makers can do — even on a global level, as Garry White reports below.

Nevertheless, it’s highly annoying that the Bank and the Government took their eye off the ball at the very time they should have been preparing for this inevitability. Cast your mind back over the last few months. Everyone fretting about the credit crunch and the housing market. None more so than the Government and the Bank of England.

The London Interbank Offer Rate (Libor) rose well above the base rate. Lenders were scared to lend to each other. So the Bank launched its special liquidity scheme. Alistair Darling had meetings with bankers, saying "Come on, chaps. Let’s get Libor down, get things going again!"

This was the main thrust of UK economic policy. Short-term and ineffective. Missing the bigger danger poking its fat, ugly head over the horizon for all to see.

Over at the European Central Bank (ECB), Jean-Claude Trichet took a different view. The Euribor — Europe’s Libor equivalent — has risen by over 100 basis points since the credit crisis began.

The ECB itself hasn’t raised its rate since June last year. Because Trichet let the market do it for him.

So... would things be different today if the Bank of England hadn’t faffed on trying to shore up house prices? Probably not. But it might have given itself a stronger hand to deal with the upcoming challenge.

As it is, we’re living in an era of 14% pay rises — the settlement that ended the Shell tanker drivers’ dispute.

The Government says that pay deal is "particular" to that industry. What it means is it hopes no other unions get the same idea...

No "magic wand" solutions to the oil price

"A politically-motivated talking-shop"

Commodities man Garry White isn’t one to mince words. This morning he was telling us about the meeting in Saudi Arabia between oil producers and oil consumers.

"A total waste of time," he says. "This will make no difference to the oil price."

Indeed, even those attending have basically admitted it’s a waste of time.

"There won't be any immediate impact on prices. There are no short-term magic wand solutions," said a White House spokesman.

All of which is why — despite some commentators fearing a bubble — Garry remains bullish on his oil investments.

Because even if the oil price fell through the floor, the companies he’s invested in would still turn a profit!

Find out why Garry believes there’s still a lot of money to be made investing in oil.

Another "action movie" investment from Manraaj Singh!

Deep in the heart of Africa, a man takes delivery of an arms consignment. As well as weapons and ammunition, the consignment contains something else. 70 military uniforms — identical to those worn by the presidential guard of Equatorial Guinea.

Yes, we’re talking about the Simon Mann trial! The man arrested for trying to stage a coup. Our emerging markets expert Manraaj is following this one avidly!

"This has got the lot!" he says. "Ex-SAS officers... a prime minister’s son... and a hell of a lot of oil!"

But Manraaj isn’t following this story just for kicks and giggles. You see, Africa is full of shady types like Mann. Secretive tycoons, ruthless mercenaries — all players in the struggle for the continent’s minerals and precious metals.

And today, Manraaj wants to tell you about another African ‘coup’ — and how the riches from this one dwarf those that Mann and his co-conspirators hoped to get their hands on.

Find out how — with this simple investment — you could make big profits in one of the most resource-rich countries on the face of the globe!

Until tomorrow

Ben Traynor

Today’s Daily Reckoning - Ben Bernanke is fighting the wrong war

Today, we turn to our war correspondents for dispatches from the front lines, and we find an important insight:

"Learn to live with inflation," begins the headline in the Financial Times. The FT refers to England’s central banker, Mervyn King, who says inflation — already running hotter than at any time in 10 years — is going to heat up even more.

In America, the news is not so different. "Globalized Inflation," is a headline in the Wall Street Journal, finally catching on. In-put prices are running up at nearly twice the rate of the official CPI figure. Prices for goods imported from overseas are rising nearly four times as fast.

In Argentina, meanwhile, the inflation rate is officially more than 8%...unofficially, it is probably twice that high.

And across the Rio Plata, Horacio Pozzo reports on "Brazil and Inflation: the struggle continues." Inflation in Brazil has just registered its biggest monthly gain in 12 years.

It looks like inflation is winning, in other words.

You can read today’s Daily Reckoning in full HERE.
P.S. If you enjoyed this article then we encourage you to sign up for the free Fleet Street Daily eletter. Learn what you can expect from today's markets -- and how to prosper in the face of uncertainty. You won't find more thought provoking writing anywhere on the Internet.

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Higher Interest Rates Could Cause More Inflation

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Higher Interest Rates Could Cause More Inflation