Is inflation rising or isn't it? The question highlights an increasing split between the government view of prices and what the Bank of England sees in relation to the ‘old' measure of inflation, the retail price index.
Figures released today by the Office for National Statistics show RPI jumped again in March to an annualised rate of 2.6% from 2.5% in February as recent rises in interest rates started to bite, pushing up overall inflation including mortgage payments.
Evidence of this effect comes from the RPIX index, which excludes mortgage payments, which shows inflation fell in March to a level of 2.1% from 2.3% in the previous month.
”The largest upward effect on the RPI annual rate came from housing,” the ONS says.
”Mortgage interest payments rose this year as lenders passed on mostof this February’s 0.25 percentage point increase in the repo rate. Lastyear, by contrast, payments fell as lenders reduced rates following aquarter point cut in the repo rate. There was also a large upwardcontribution from the house depreciation component, with house pricesrising this year but falling a year ago. “
The Bank’s problem is that even though inflation is being stoked by rising house prices and mortgage interest payments, the government is fixing policy according to CPI, the Consumer Price Index, not RPI or RPIX.
CPI inflation hit 1.1% on an annualised basis in March, down from 1.3% in February as falling transport and energy costs translated into slower price rises. The rate was 1.4% as recently as January this year.
If CPI continues to fall and the Bank puts up rates again, as market swap rates suggest, then Bank governor Mervyn King will face pressure from the Treasury to explain his policies in writing – a right reserved by the government when it allowed the Bank freedom to set monetary policy in 1997.
The government’s CPI target is 2%, in line with the Harmonised Index of Consumer Prices used by the European Central Bank to set rates for the eurozone. This implies the Bank has considerable room to cut UK interest rates before CPI hits the target.
King has previously stated the Bank will continue to rely on RPI as one of the measures of inflation when making decisions on UK interest rates, despite the government’s insistence on using CPI as the main measure.
But, as the two indices move further apart, the differences in view as to what is happening to prices in the UK is going to widen, potentially setting up an issue of intervention by the government into the framework used by the Bank to steer monetary policy.
Further pressure on the Bank not to lower rates has come today, with the UK’s second biggest house builder Taylor Woodrow reporting reservation and visitor numbers to its new homes and estates well ahead of last year’s figures.
More than half the company’s planned house sales for all of 2004 are already either completed or reserved, with the average price for one of its houses up by 6% to £192,000 so far this year.
The Centre for Economic and Business Research says the latest figures imply the Bank’s forecast that CPI should hit the 2% target within the next two years is undermined.
”We expect inflationary pressures on the CPI measure to remain muted over the coming year,” the CEBR says.
However, the fact housing costs are rising sharply is also not being sufficiently recognised in CPI, it adds, leaving the markets to factor in another likely interest rate rise by May.IFAonline
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