Today is the day the Bank of England will probably do nothing. Well, that’s a bit harsh. It will fret, and worry, and then fret some more. But then it will almost certainly do nothing. (Watch out for its announcement today to see if it actually surprises us all and does something, leaving us with egg on our face.)

But the pressure on it to up rates is becoming stronger.

The latest BRC survey had food inflation rising 4 per cent in the year to December. Commodity prices keep going up, VAT is up again, petrol is becoming ridiculous, and if China really does appreciate its yuan, won’t that make China’s products more expensive?

But then again, think of it in these terms. Most UK households have mortgages, meaning they probably pay more interest on their debts than they receive on their savings. This means they are worse off if rates go up. But these people are already worse off anyway; wage growth is set to lag way behind inflation this year. So if rates do go up, we will be seeing a double blow on households.

Interest rates are meant to influence inflation through their effect on demand. Higher rates bring down demand, pushing prices down. But the forces that are pushing up on prices at the moment have nothing whatsoever to do with UK demand.

But there is one snag.

Yes, it is true that factors creating inflation are external at the moment, and therefore an increase in interest rates will just make things harder for households without dealing with the cause of rising prices. But wasn’t a similar argument, albeit applied to opposite circumstances, completely ignored by the Bank of England earlier last decade?

During the boom, inflation was low because of external factors – cheap manufactured goods from China, mainly. But the Bank of England said, inflation is low, so let’s cut interest rates. As a result, people who were already benefiting from cheaper products had the added benefit of lower interest rates. No wonder the economy overheated. Or is that understating it – no wonder the economy boiled over.

Of course, back in the boom years central banks got a tad arrogant. “Low inflation, consistent growth was down to us, aren’t we clever,” they said. Well, it wasn’t. Now they are saying higher inflation and lower growth isn’t down to us. Well, they are right – sort of. But then again, they can’t have it both ways.

And finally, before we leave this topic, there are a number of forces that are coming into play that could create a new bout of inflation in the decade to come. Firstly, over the next decade, or even longer, growth in demand from the developing world is likely to exceed growth in savings – creating higher interest rates and inflationary pressures. Secondly, it seems wages in China are set to rise; this may well have inflationary implications. Finally, as the baby boomers retire, they will dip into their savings, and spend money even though this rise in spending may not be matched by higher production from the diminishing labour pool. This too could have inflationary implications. See: Interest rates set to rise as economic tectonic plates shift – is this good or bad news?

See http://www.investmentandbusinessnews.co.uk/economic-growth/interest-rates-set-to-rise-as-economic-tectonic-plates-shift-is-this-good-or-bad-news/12136

For the time being, we would argue that deflation remains a bigger danger to the developed world than inflation. But this could change over the next few years – but the change will have nothing to do with quantitative easing.

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