The pound has been creeping up. Talk that interest rates will soon be rising is hitting a crescendo. They are connected, but the real danger right now lies with an illusion about money.
Back in October there were 1.13 euros to the pound. Over the last few day the exchange rate has been rotating around 1.20.
On the last day of 2010 there were 1.54 dollars to the pound; as of Friday there were 1.60.
The pound has been rising, and according to Capital Economics, it is expectations that rates will be rising in the UK soon that are causing the rises.
It’s not helpful. If the UK is to enjoy an export-led recovery, we need sterling to remain cheap, which is why it was a tad odd when last week David Cameron seemed to join the cause of those wanting to see higher interest rates in the UK.
But there is one rather worrying trend we are seeing at the moment that may indeed force the Bank of England to up rates.
On Saturday morning, BBC Breakfast ran two stories in a row which illustrate the problem. The first story was on rising charges at car parks, the other on rising petrol costs. Both stories said prices are rising because of a combination of rising inflation and rising VAT.
In fact, the correspondent talked about prices going up 6 per cent, because that’s what you get when you add inflation to the VAT hike.
The story is daft, of course, because the VAT rate is already included in the inflation figures. VAT went up in January 2010 and it went up this January, and this has pushed inflation up.
To add VAT to inflation is double accounting, as you are adding in the same variable twice.
If unions were to adopt that philosophy, they might start striving for wage increases of 6 per cent. That really would be a concern.
People’s expectations of inflation matter. If we expect inflation to rise, our behaviour can make the very thing that we expect to happen actually more likely to occur. In short, our inflation expectations can be self-fulfilling. And the current media talk of rising rates is in danger of making that a necessity; that would be bad news for the UK’s indebted households, and bad news for our exporters.
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