Inflation & Unemployment

At long last, UK inflation has hit target… but soon, so too will unemployment.

Chart showing CPI Inflation since January 2000

The graph says it all. Inflation, as measured by the Consumer Prices Index (CPI), hit 2.0% in December 2013, ending the year on target. The last time inflation was on target (actually 1.9%, 0.1% below) was November 2009. The main reason for that was the reduced 15% rate of VAT, which lasted from December 2008 to January 2010, temporarily cutting prices.

The 2% target is one that the Bank of England has forecast to be achieved in each quarterly Inflation Report within a two year timescale. It has made this prediction so often that the markets had begun to regard it as a joke. Mark Carney, the Bank’s recently appointed Governor, is lucky that six months into his reign inflation is at 2.0%. His predecessor, Sir Mervyn King, was condemned to a regular correspondence with the Chancellor of the day explaining why inflation was more than 1% above target.

On-target inflation will also help ease another benchmark-related problem which Mr Carney is facing. His “forward guidance” that interest rates would not be reviewed until the unemployment rate reached 7% is likely to be tested much earlier than the mid-2016 that the Bank had originally expected. The latest unemployment rate (for September – November) was 7.1%, a fall of 0.3% from the previous reading. That makes it a fair bet that 7% is months away, at most. If inflation remains around 2%, Mr Carney will be able to say after his triggered review that there is no need to push up interest rates, simply because unemployment has fallen.

And just as a reminder, next month marks the fifth anniversary of 0.5% base rates…