The Bank of England, or at least its Governor Mervyn King, is finally admitting what has been blindingly obvious for some time: inflation is a serious threat.
With the rate of price rises running above the 2% central target rate for most of the past four years and topping the 3% ceiling since the beginning of this year, it is hard to understand why fears of deflation have persisted, though they still recur among some commentators, if rather less frequently than they used to.
In one sense it is reassuring that even the Governor of the Bank of England is human. On the other hand it is worrying that the most important financial figure in the country after the Chancellor of the Exchequer has got inflation so wrong. He has in the past expressed surprise that inflation has stubbornly refused to fall as he expected. Now, belatedly, he has dropped any pretence that the rate will reach the 2% target in the foreseeable future.
One reason for his dilemma has been the actions of this and the previous government in creating the inflation that the unfortunate Governor then has to explain away. With another VAT increase coming into force next January, just as the previous increase will drop out of the calculations, we must expect inflation to persist at least until well into next year.
The possibility that the economy is recovering much faster than expected would normally increase inflationary fears, although these are not normal times. Growth of 1.1% in GDP was about double what economists were expecting. The increase was spread across most sectors, which is encouraging, but was seen most particularly in construction, which leapt 6.6%.
Incidentally, I feel that many shares in the construction sector are undervalued as they fail to take account of the recovery. I know housebuilding faces a particularly difficult future but shares in that sub-sector are particularly bombed out.
Already the arguments are being trotted out for not believing the growth figures. They could, admittedly, be revised downwards although in a recovery they tend to edge upwards as later figures are included.
King points out that too much store should not be put by one set of figures. That is also true but we have now had three successive quarters of growth. In the first half of this year the improvement was 1.4%, which already beats the Treasury’s own forecast of 1.2% for the full year, a figure that was itself supposedly wishful thinking but will now have to be revised upwards.
Another argument is that lending is falling. If we are building a recovery on less borrowing then that is surely a good sign.
I do not expect a repeat of the second quarter's growth over the rest of 2010. It is a fair argument that part of the surge has come from restocking by companies that ran down their inventories during the recession. However, it is worth noting that the transport services industry contracted by 0.7% in the second quarter thanks to the disruption caused by the volcanic ash cloud in April. This reduced the overall total by 0.1% and will, we hope, not be repeated.
The possibility of further quantitative easing has been raised. King seems keen but he will have to persuade other members of the monetary policy committee who showed less enthusiasm for pumping more money into the economy than he did as the programme wound down.
One committee member has voted for an increase in interest rates at the past two monthly meetings. The possibility of a rise in interest rates before year end sits uneasily with ideas of stoking the fires of inflation by printing more money.
I would support the idea of quantitative easing if the money was pumped into private companies rather than the government, which was the recipient of almost all the £200 billion dished out so far. If high street banks are so reluctant to support small and medium sized businesses then perhaps the Bank of England could set an example. I don’t think that will happen, though.
Meanwhile shares have settled down well after the early summer wobbles. There is still a long way to go but I am again sufficiently confident to argue that it is sound policy to buy into companies with strong yields.
Shell In
It is surprising that the very strong quarterly figures from Royal Dutch Shell have been received with so little enthusiasm. I cannot help feeling that the disaster at BP has somehow tarnished its rivals in the eyes of investors.
I have to declare that I hold a stake in Shell which I am holding for income over the long term. A 15% rise in profits confirms that view. I know which company I would rather buy into at this stage and it isn’t BP.
Rodney Hobson is a private investor writing about his own portfolio. The opinions expressed in this column are those of the individual, and not of Morningstar, and should not be construed as financial advice.
