OPINION - The problem: Britain’s economy cannot grow without generating inflation

 (Michelle Thompson)
(Michelle Thompson)

“I ask the court to judge which is worse,” urges the handsome but painfully earnest Dylan McDermott. “A lie that draws a smile or a truth that draws a tear?” This rhetorical flourish is problematic even by Hollywood’s standards, given that Kris Kringle’s lawyer in Miracle on 34th Street appears to be suggesting his client is committing perjury.

The Office for National Statistics, on the other hand, has no such qualms about delivering tear-inducing truths, which is just as well. This morning, it published inflation data that continues to leave the government and households squirming.

The Consumer Prices Index rose by 8.7 per cent in the 12 months to May. In other words, despite all the pain of higher interest rates, inflation remains unchanged. But the ONS wasn’t done yet. Core inflation, which strips out more volatile prices such as energy and food, rose by 7.1 per cent – that is up from 6.8 per cent in April and represents the highest such figure since 1992.

All this makes an interest rate rise at tomorrow’s meeting of the Monetary Policy Committee a racing certainty, and that means more pain for anyone unfortunate enough to be coming off their fixed-rate mortgage anytime soon.

And the impact of higher rates has been laid bare by a new Institute for Fiscal Studies report, which warns that 1.4m borrowers – including 300,000 in the capital – will see their mortgage rates rise by at least 20 per cent of their disposable income as they move onto higher rate deals. Yikes.

Note: it is true that 6 per cent interest rates, as are now predicted for the start of 2024, are not in the same league as the 10-15 per cent of the 1980s. Yet this is a false comparison, because rising house prices mean that mortgages are larger, both in real terms and relative to earnings, than in decades gone by. 6 per cent is pips-squeaking territory. (Though only for some. Remember, more than half of UK homeowners do not have a mortgage).

But we now turn to the truly depressing part: the absence of a boom. In inflationary episodes of yore, a dash for growth (see Barber, Lawson) caused the economy to overheat which led to rising prices, higher interest rates and an economic downturn. This is not that. Save a bit of pandemic bounceback, GDP growth has been nothing to write home about for years. Real earnings have scarcely grown since 2005. And yet we still have to raise interest rates to crater demand. This is a supply-side problem too.

The UK’s productive capacity has been hampered by all manner of political choices, including but not limited to: low investment (both private and public), a still tight labour market (in part thanks to record NHS waiting lists driving long-term sickness), Brexit trade friction, weak transport links and planning restrictions that mean we have nowhere near enough homes. These have been exacerbated by two further economic shocks, in Covid and Russia’s invasion of Ukraine.

We could attempt to address some of these issues and boost aggregate supply, but it would be expensive, difficult and crucially wouldn’t help with the current bout of inflation. Therefore, all we can do is choke off demand.

I think we’re passed the point of looking at Rishi Sunak’s pledge to halve inflation by the end of the year and calling it a political problem. The issue isn’t the pledge. It is that the British economy appears incapable of delivering sustained growth without the accompanying inflation. And that is because our productive capacity does not for allow it. This seems to be a far more serious problem than whether the prime minister manages to keep a particular promise.

In the comment pages, Stephen King says the Bank of England acted too late on inflation and now homeowners will pay. Katie Strick yearns for a city in which cycling was for everyone, not just men in Lycra. While Simon English says if you think London is getting you down, try Paris - it’s much worse. Not content with that, Simon also has a piece in the City pages in which he ponders whether a house price crash might be just what our society needs.

And finally, a new poll has found that four of the capital’s most stylish neighbourhoods are in south London. Sure, Jan.

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