Reading the FT's Martin Wolf on UK inflation has been frustrating. He has ceaselessly argued the dovish case for keeping rates on hold. At the same time, UK inflation has become an increasingly grave problem. The RBA will be watching UK events unfold with tremendous interest, and unease. For mine, Wolf makes several logical mistakes:
1/ He, like other dovish commentators, rationalises away UK inflation by attributing it to the Sterling's low value. That is, so-called external factors, or imported inflation. But the Sterling's low value is in turn a function of UK monetary policy, and the incredibly low 0.5% cash rate that the BoE is persisting with;
2/ He, like others around the world, claims there is no problem with inflation expectations by referring to break-even inflation rates determined by institutional investors in the bond market. Earth to all commentators/economists: *consumer* price inflation is not determined by institutional investors! I don't know how many times I have to point this out, because it seems to be a novel argument. Compare consumer inflation expectations in Australia or the US with their bond market equivalents and they bear little resemblance. Of course, it is convenient that institutions seem to be less influenced by galloping headline inflation;
3/ He, like many others, claims that the existence of so-called 'output gaps'--viz., theoretical spare capacity--following the acute North Atlantic recessions means that domestically generated inflation cannot possibly materialise. The problem is, it is materialising, in both the UK and, more recently, in the US. And that's likely because this so-called "capacity" that existed before the GFC was bogus, and did not deserve to exist. Said another way, it is of little relevance to the post-GFC economy.
Wolf is finally getting worried about UK inflation. He is not worried enough.
