VAT rate and interest rates
Discussion
In the light of yesterday's (not unexpected) hike in VAT presumably this will have a significant impact on inflation come January - and as a result presumably interest rates will have to be hiked up around March next year by the MPC once this has filtered through?
I know there are a lot of factors at play and that for example reductions in public spending will be deflationary in effect, with a similar effect from reduced spending by consumers, combined with a low growth rate.
I am not an economics expert, none of us have a crystal ball etc, but am wondering what people who are perhaps closer to this than me think on balance?
I know there are a lot of factors at play and that for example reductions in public spending will be deflationary in effect, with a similar effect from reduced spending by consumers, combined with a low growth rate.
I am not an economics expert, none of us have a crystal ball etc, but am wondering what people who are perhaps closer to this than me think on balance?
It depends on what the retailers do.
Ceteris paribus, next year all the VAT-affected prices will be going up 2.13% owing to the change. (=1.2/1.175-1)
At this point the retailers have to make a choice. Do they ALSO raise prices or not?
Assume they achieve 2% like-for-like price rises in a normal year - that translates into inflation, of course.
They could either aim to do that again (ex-tax) i.e. raise prices closer to 4% in total from a consumer and inflation point of view.
OR they could just take it on the chin and not put any price rises for themselves.
If the latter, then inflation will look pretty normal.
I think most economists view that the retailers will take it on the chin, so inflation will be in-line-ish with a normal year.
Also, remember that price rises affect demand for retailer's products, so raising prices an effective 4% may kill off the demand fairly dramatically. i.e. the retailers may not be able to raise prices that much (well they could but it wouldn't be in their best interests).
Also from the rhetoric at the MPC they tend to look through any inflation driven by VAT rises since it is one-off rather than structural.
Ceteris paribus, next year all the VAT-affected prices will be going up 2.13% owing to the change. (=1.2/1.175-1)
At this point the retailers have to make a choice. Do they ALSO raise prices or not?
Assume they achieve 2% like-for-like price rises in a normal year - that translates into inflation, of course.
They could either aim to do that again (ex-tax) i.e. raise prices closer to 4% in total from a consumer and inflation point of view.
OR they could just take it on the chin and not put any price rises for themselves.
If the latter, then inflation will look pretty normal.
I think most economists view that the retailers will take it on the chin, so inflation will be in-line-ish with a normal year.
Also, remember that price rises affect demand for retailer's products, so raising prices an effective 4% may kill off the demand fairly dramatically. i.e. the retailers may not be able to raise prices that much (well they could but it wouldn't be in their best interests).
Also from the rhetoric at the MPC they tend to look through any inflation driven by VAT rises since it is one-off rather than structural.
The red book gives projected CPI & RPI and then the queston is how the MPC reacts to CPI changes in excess of its target. So far it hasn't been keen to raise rates, either through fear of squashing recovery or because it thinks CPI will drop back. The C&RPI graphs are flattening off a bit at present http://www.statistics.gov.uk/cci/nugget.asp?id=19 and as mentioned above, reinstatement of 17.5% didn't show that much of an effect. There isn't going to be much public sector money to allow wage inflation in that sector. As Beardy says below, every % inflation reduces government debt by huge amounts - inflation matched by wages is also populist in the short term as debt, mortgages especially, dwindle and wages appear to rise. Though savings dwindle as well, many people have no significant cash savings so they don't care, and those who do often get a better interest rate so don't feel the full effect. In the long term it is very destructive*, hence the BoE / MPC target, and if wage inflation is curbed (as it will be in the public sector), people will certainly notice price inflation!
- the reason for me banging on about index-linked NS&I certificates in the past....currently paying RPI+1% - the equivalent of 10.1% gross for a higher rate taxpayer.
Edited by nomisesor on Thursday 24th June 08:37
Don't think you'll ever hear anyone from No 10 or No 11 say it but they are very happy to see a little more inflation....inflation obviously helps to reduce the size of the deficit. So I don't think we'll see a rise in rates...let's not forget the BoE base rate is the rate at which banks borrow not the consumer. Low BoE rates help the banks banks repair their balance sheets (which still have a LOT of distressed assets) and ultimately enable them to step up lending in the future.
NoelWatson said:
Beardy10 said:
let's not forget the BoE base rate is the rate at which banks borrow
?The official bank rate (also called the Bank of England base rate[1] or BOEBR) is the interest rate that the Bank of England charges Banks for secured overnight lending.
http://en.wikipedia.org/wiki/Official_bank_rate
It's a cornerstone of how the banking system operates............
Beardy10 said:
NoelWatson said:
Beardy10 said:
let's not forget the BoE base rate is the rate at which banks borrow
?The official bank rate (also called the Bank of England base rate[1] or BOEBR) is the interest rate that the Bank of England charges Banks for secured overnight lending.
http://en.wikipedia.org/wiki/Official_bank_rate
It's a cornerstone of how the banking system operates............
NoelWatson said:
I've not seen anyone use BOE rate in banking applications, hence my question. LIBOR is used throughout in my experience.
Sure but as we know from very recent history many banks could not borrow at Libor or even at any spread above Libor in the the unsecured markets. In practice most banks obviously don't borrow from the BoE but as it is the price the lender of last resort sets for it's lending to the banking system which is absolutely key.honest_delboy said:
So in theory if banks are borrowing at 0.5& then lending for mortgages at between say 4-7% then they must be COINING it in.... but hiding it well as their divi payout would be massive and no one wants banks doing well in this climate.
Or have i got it completely wrong?
No you haven't. The reason why we are not seeing huge profits from the banks is that many of them still have a lot of loans or assets on their balance sheets which are losing money. So the profits from new lending is going towards writing off or writing down all those bad loans. In reality obviously the banks are actually borrowing money at less than 0.5% because they have access to the money in people's current accounts or deposit accounts which they are effectively borrowing from us at much less than 0.5%. That 0.5% rate is only used as a last resort.Or have i got it completely wrong?
I guess inflation may be kept in check as the "too much money chasing too few goods" situation will be supressed by the impact of tax/ni changes.
Although I earn more now than I have ever done I haven't felt as badly off for a long while. Feel like I should be saving/economising/reducing mortgage.
Although I earn more now than I have ever done I haven't felt as badly off for a long while. Feel like I should be saving/economising/reducing mortgage.
We will probably see a jump in the inflation figures feb/mar time due to the vat but the mpc will know what part of that jump - all of it? - is due to the vat rate increase. In this case they will take a fairly relaxed view as they will expect the inflation rate to drop 12 months later. Don't forget inflation jumped to I think 3.7% a few months ago and they said 'yeah, should drop later in the year' and didn't change the rates.
Back in the 70s any increase in inflation led to increases in wages and so on in a wage-price-spiral of increases. This is less likely to happen now due to union weakness, public sector pay freezes etc.
Also there's 200bn in qe to be unwound at some point. Not sure if they do this before increasing rates as well.
A lot of economists are expecting moderate interest rate rises from later in the year - hopefully it will be nice and slow.
Back in the 70s any increase in inflation led to increases in wages and so on in a wage-price-spiral of increases. This is less likely to happen now due to union weakness, public sector pay freezes etc.
Also there's 200bn in qe to be unwound at some point. Not sure if they do this before increasing rates as well.
A lot of economists are expecting moderate interest rate rises from later in the year - hopefully it will be nice and slow.
Beardy10 said:
NoelWatson said:
honest_delboy said:
So in theory if banks are borrowing at 0.5& then lending for mortgages at between say 4-7%
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