Intelligentguess

Back ground

An inflation target was first set in October 1992 by then-Chancellor of the Exchequer Norman Lamont following the departure of the UK from the Exchange Rate Mechanism.

Initially, the target was based on the Retail Price Index (RPI ) excluding mortgage interest payments. Since 1996 the United Kingdom has also tracked a Consumer Price Index ( CPI ), and in December 2003 its inflation target was changed to one based on the CPI.

Until 1997, interest rates were set by the Treasury.

Current

Since May 1997 the Monetary Policy Committee of the Bank of England sets interest rates, on the basis of an inflation target set by the Chancellor.

If in any month inflation is more than one percentage point off its target, the Governor of the Bank of England is required to write to the Chancellor explaining why.

Official Bank Rate history

Minimum Band 1 Lending Rate: Data refers to the minimum published rate the Bank discounted bills at to relieve money market shortages (excludes late assistance and repurchase and sale agreements).

(source of raw data: Bank of England )

Share This

UK CPI annual inflation – was 2.7 % in January 2007, down from 3.0 % in December 2006 ( highest since September 1992 @ 3.07 % - the next highest in the recent past was at 2.96 % in December 1995 )

The largest downward effect on the CPI annual rate came from transport costs. Prices of fuels and lubricants fell this year, but rose a year ago. There was an additional large downward effect from air travel, mainly due to changes in the cost of fares to European destinations. ( note : Housing costs excluded from the CPI had a large upward effect on the RPI this month, mainly due to the mortgage interest payments component, with some lenders passing on January’s quarter point increase in the Bank rate. A further small upward contribution came from the depreciation component (the amount needed to maintain the dwelling at constant quality).

As an internationally comparable measure of inflation, the CPI shows that the UK inflation rate is above average for the European Union as a whole. The provisional inflation rate  in December for the EU area was 1.92 % ( EU 25 was 2.1 % ) compared with the UK rate of 3.0 % for the corresponding period.

Data and some information of the above note are sourced from UK - National Statistics Online

Whats happening ?

The Bank of Englands inflation target is 2%. This is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI).

PPI has been growing since November 2001 ( - 1.39%) and peaked out in 2004 December (  3.54% ) . Since then PPI was ranging between 3.4 % and 2.4 %.  PPI has started dropping since June 2006 from 3.4% to 1.58% in October 2006 ( lowest since March 2004) . It is currently at 2.13% ( January 2007). 

CPI has been growing since June 2002 ( 0.63%) and peaked in December 2006 ( 2.97% ) . 

The Bank of England raised the Bank Rate by 0.25% to 5.25% in January 2007.

The latest figures show that the January 2007 CPI ( annual growth rate ) is at 2.69% .

As can be seen in the chart PPI direction tends to lead the CPI. ( click on  thumbnail to get the larger picture)  

The Situation

PPI has had a strong drop , and does not look like it will be rising in the immediate future. It would most probably range between the 1.25% - 2.50% area.

The CPI look like it has peaked , and based on its behaviour viz a viz PPI - it could be expected to propably range initially ( 2.30% - 2.90 % ) and then drop down towards/below 2%. ( the Banks target rate)

The Conclusion

- Bank of England cannot be expected to raise interest rates from here on .
- IF the rate drops below 2% ( a possibility - post 6 months ) - the Bank of England would need to consider  possibly - dropping interest rates.

Share This

The Producer Price Index (PPI)  declined 0.6 percent in January 2007 ( as compared to the previous month).  Click on thumbnail for the “larger picture”

The PPI grew by 0.19% p.a in January 2007 ( as compared to the same period last year).

Finished energy goods prices declined 4.6 % in January compared with a 2.2 % advance in December ( both as compared to teh previous month).

Both the CPI as well as the PPI have declined sharply since June 2006 . Both are at the lower end of their respective range since 1990 ( see chart ). Inflation does seem under control .

In the current situation the Fed would put on hold any possible increase in interest rates.

There is plenty of chatter in the market that the Fed could possibly reduce interest rates.

However - in the current situation where in :

Fiscal deficit and the negative savings rate is slowly reducing  - the Fed may decide to retain the current stance ( specially until some kind of a savings rate actually exists)

Share This

The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives.  The Government’s inflation target is announced each year. This is expressed in terms of an annual rate of inflation based on the Consumer Prices Index (CPI).

The purpose is not to achieve the lowest possible inflation rate. Inflation below the target  is judged to be just as bad as inflation above the target. The inflation target is therefore symmetrical.

Currently the Bank of England’s  inflation target is 2%.

source : Bank of England

Share This