Editor's letter

Why the UK's 2.5% inflation is a big deal

After years of inflation being a financial-assets problem, it is now an “ordinary things” problem too, says Merryn Somerset Webb. But central banks still insist it is transitory.

In May, annual inflation in the UK as measured by the CPI (consumer price index) rose to 2.5%. This doesn’t sound very much, and it shouldn’t be much of a shock to regular readers: we’ve been worrying about inflation for some time. But that doesn’t mean it isn’t a big deal. It’s higher than most analysts expected for the third consecutive month (the consensus forecast was 2.2%) and the highest since 2018. It is 25% higher than the Bank of England’s target (2%) and six times higher than it was in February. Note also that our old measure of inflation, the RPI (retail price index), is 3.9%. The problem is not confined to the UK: in the US, CPI is rising at 5.4% a year. 

This matters. Central banks still insist it is transitory – the base effects of last year’s falling prices working their way out of the system. But it could easily be more: as Capital Economics notes, in the UK “the rises are bigger than the base arithmetic would suggest which means that genuine price inflation is happening too”. How much? The Bank of England reckons it will top out at 3%. Capital says 4%. Both look low to us, given how much inflation you can see around you. You can see it in labour shortages (next week’s podcast guest Brian Pellegrini says that workers have “repriced their leisure”, so employers have to reprice their work). You can see it in the art market (see this week's magazine for the £8.9m just paid for a Leonardo da Vinci sketch and the near-£3m for a 1970 Patek Philippe watch). You can see it in house prices. You can see it in equity prices – the S&P 500 hit yet another record on Wednesday. 

But most importantly of all, after years of inflation being a financial-assets problem (a problem because it exacerbates wealth inequality) it is now an “ordinary things” problem too – for example, in the US, used car prices are up by 45%. In any normal world, interest rates would already be rising. But not in this world. After years of terrible post-financial crisis policy making, the authorities are stuck, as Bill Blain of Shard Capital puts it, between the Scylla of inflation and the Charybdis of a market and house price collapse. They are terrified of the latter so feel they must put up with the former. They won’t act in time to head it off.  

You can’t ignore this “monetary disease”. We’ve looked at many ways to deal with it over the last few years. But this week’s podcast with Russell Napier is well worth a listen: despite the extraordinary house price boom, he’d still buy residential property. Another hedge might be commodities – David Stevenson has view on a new fund that might do the trick. 

We might also think about what else societies have mentally repriced along with their leisure time. I wonder if it might not be our health. Private GPs and hospitals have seen demand surge. Given the state of the NHS at the moment, there will be many more surges to come, and private healthcare will look increasingly like a good investment. There’s a US idea on this in this week's magazine, but we will look at ways in to the sector in the UK in a future issue. 

Finally, for yet another Covid-19 casualty, we look at the insane amount of money floating around the Olympics. The London Olympics cost about £10bn (admittedly small change next to the £14bn-a-month peak furlough cost). But the Tokyo Olympics are coming to more like £19bn. How’s that for inflation?

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