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The ‘Pension Bubble’ and more letters to the Chancellor

Another horrible data point this week, with the official CPI rate now running at 4.4% annually. Up from 4% last month.

We’ve now been above the BoE 2% CPI target since december 2009 – and the bank rather jokingly claims that the 2% target is still relevant. One wonders how a private business would fair if it was over 100% off its target for such a long period of time.

 

Just about all vectors in the inflation basket were rising except alcohol and tobacco. This after a record rise in prices between December 2010 and January 2011. However, expect to see a sharp reversal in this trend the next time the ONS releases its figures and for alcohol and tobacco to be leading the price surges.

The reason? Osbourne’s recent budget. From March 28 a pint will go up 4p, a bottle of wine 15p and a whopping 54p will be added to a bottle of spirit. On the cigarette side expect ‘cheap’ branded ‘devil sticks’ to rise by 50p and more expensive brands to go up 33p.

Aside from the obvious higher cost to the public, higher CPI numbers will start to be a real drag on government finances as well. After recent changes to the way public pensions are calculated, they are set to rise annually at 2.5% or average earnings or CPI – whichever is the highest measure.

With average earnings in the doldrums the government will be committed to raise state pensions by the higher CPI figure. Although it is fortuitous they changed the measure from RPI to CPI last year – RPI is currently 5.5%, a full 1.1% higher than CPI. Should we see higher CPI prints in the coming months this could start to be a real headache for the government.

At the moment the UK government will spend over £120bn on pensions in 2011. A quick back of the (just gone up 50 pence) fag packet calculations tells us why a rising CPI might become a massive problem in the future. If the BoE was hitting it’s 2% target those pension costs would look to rise by £3bn next year. But instead if CPI holds around 4% for the year pension costs will increase £4.8bn next year. A not insubstantial extra £1.8bn cost. But happens if CPI doesn’t hold at around 4% but instead rises much more dramatically, say 8% or 10%? You can see how quickly this could get out of hand.

And this is only looking at public pensions – private pensions are also a risk because many have RPI and CPI ‘escualtors’ built into them as well. We could see already vastly underfunded pensions in the UK get into some serious hot water should this trend continue.

Then there are public sector workers, who will be clamoring for above CPI pay rises this year, should that happen then expect a very quick move into ‘Weimar’ territory for this country.

So what do we have, ‘the pension bubble’ anyone? It is often (rightly) claimed that the real reason for the BoE printing money (Quantitate Easing) and its total disregard for the 2% CPI target is because it desperately wants inflation to reduce the massive debt burden in the UK in real terms. For example if you cut in half the value of the pound, you also cut in half the value of the debt held in pounds at the same time.

However, where this falls apart are the increases to things like pensions and wages that the government is legally obliged to make – so as inflation rises diminishing the cost of debt, the government is also committed to spend more on things like pensions to cover the cost of living expenses, meaning that it will have to borrow more to make good on these promises. It’s a vicious circle and the higher inflation goes, rather than making the debt go away, the debt will actually increase to cover the extra commitments. In short, it’s unsustainable and what can not last, wont.

So is this the last of the CPI rises and we’ll see inflation start to tick back down? Well, according to those target hitting geniuses over at the Bank of England we could see CPI get over 5% in coming months.

In their most recent minutes some interesting observations are to be had:

 

“The near-term outlook for inflation had deteriorated further, with a material chance that inflation would exceed 5% later this year”

 

“That member noted that the prospective strength of imported inflationary pressures, and therefore goods prices, combined with the resilience of service price inflation, meant that CPI inflation was unlikely to return to the target with Bank Rate at its current level.”

 

“Adam Posen voted against the proposition, preferring to increase the size of the asset purchase programme by £50 billion to a total of £250 billion.”

Adam Posen once again shows his American roots and totally confirms his bio’s claim that he was a visiting scholar at the Federal Reserve Board in that he actually wanted to INCREASE the BoE money printing program by £50bn – Inflation be damed it seems.

Again no mention that it might be all that money printing and low interest rates that have contributed to the price rises. It was all VAt and external oil shocks apparently.

So the BoE sees inflation at 5% and that “CPI inflation was unlikely to return to their target with Bank Rate at its current level”. In other words a veiled threat that they might hike rates – the market doesn’t seem to be buying it though, and even if we were to see a 25bps ‘surprise’ move, it’s worth remembering that this would still mean that interest rates are at historic all time lows.

Even with a rate rise it would not be surprising to see inflation at that point start to run away from the BoE, a re-run of the 80s and only fixed when interest rates got well into double figures. A repeat of which would bankrupt the government and our banks over night. Quite a hole those econ-phd pushers at the central bank have dug for themselves… and the price of shovels keeps on-a-rising.

 

Link to this article: : http://www.goldmadesimplenews.com/gold/the-%e2%80%98pension-bubble%e2%80%99-and-more-letters-to-the-chancellor-3215/

Posted by on Mar 24 2011. Filed under Gold News. You can follow any responses to this entry through the RSS 2.0. Responses are currently closed, but you can trackback from your own site.

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