Inflation nation

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Inflation nation

Inflation may be quiet now. But not for long, writes Paul Lewis

I have banged on about the dangers of inflation taking off several times in this column. But with the RPI now plunging faster than bank shares you may be wondering 'did he get it right?'

Annual inflation of less than 1% is rare – you have to go back to 1959/60 to find it below that level for any period of time. For seven months over that period it was actually negative, as prices fell year on year. And the predictions are that for the first time in nearly half a century inflation will be negative again this year. That will probably happen sooner rather than later. Deflation – prices falling year on year – could be with us as soon as next month, and almost certainly by the spring.

So why worry about inflation when prices are plunging? Because it is coming back. We may not feel its heat at the moment, but the fires of inflation are being stoked by three things.

First — printing money. If the Government expands what is called the money supply, without having anything in the real economy of what we make and sell to back it up, that pushes up inflation. If you have something worth £100 and have 100 notes to represent it, each of those notes is worth £1. But if you then print £120 notes to represent the same stuff, each is worth less. That is what the Government is planning with what is now called 'quantitative easing'. Creating money to boost the economy.

Second, if the value of a nation's currency falls internationally, that boosts inflation. We imported £456bn of goods and services in the year to the end of September 2008. Since then the pound has plunged 30% against the dollar and 20% against the euro. That puts up the price of what we import by around a third — adding £150bn onto prices.

Third — and you will notice all these are related — growing Government debt boosts inflation. And the Government is planning a massive borrowing spree to pay money to the banks and, now, the car industry, not to mention the cost of rising unemployment. Government borrowing hit its highest figure since the aftermath of World War II last month and could reach £50bn this year.

At the moment these three powerful forces are being kept in check by the recession, as we all do less and buy less. But when the upturn begins, inflation will be released. Remember August 1975? It was 26.9%.

Written by Paul Lewis. Paul is the editor of Saga Magazine's Money News section, a regular financial expert on BBC Breakfast and the presenter of BBC Radio 4's Moneybox. Paul's opinions are his own and for general information only. Always seek independent financial advice. This article was published on January 28, 2009.