Press Story

With all the major political parties committed to deficit reduction next year, IPPR's chief economist warns in his annual New Year Message, that the greatest risk to Britain's economy is not rampant inflation but stagnation and deflation caused by rapid rate rises. Writing for the Left Foot Forward blog, he urges the Bank of England to "freeze, don't squeeze" in 2015.

Tony Dolphin, IPPR Chief Economist, said:

"The main argument for higher interest rates is the strength of economic growth and the associated fall in unemployment.

"Most forecasters expect growth to ease in 2015, reflecting weaker growth in the global economy – what David Cameron has identified as 'red lights'. However, this weaker global growth has brought with it the considerable dividend of lower oil prices. These have already caused a big drop in petrol prices and energy companies are under pressure to cut gas and electricity prices.

"There is no reason to believe that another year of growth of even 3 per cent would lead to a marked increase in domestic inflation pressures. In particular, wage inflation is likely to remain well below the level believed to be consistent with the inflation target.

"For a brief period between August 2013 and February 2014, Mark Carney – the Governor of the Bank of England – linked consideration of interest rate increases in the UK to the level of unemployment, suggesting that rates were more likely to go up when unemployment fell below 7 per cent. With hindsight, this was a mistake. Unemployment is now 6.0 per cent but interest rates have not increased because low unemployment has not been accompanied by evidence of wage pressures.

"The labour market in the UK is now too complex to be judged by the rate of unemployment alone. Rapid employment growth, steep falls in unemployment and an employment rate back to the level seen before the financial collapse all give a potentially misleading picture. Involuntary part-time and temporary working are at high levels and many people are self-employed when they would rather be working as an employee. Only when overall employment growth is accompanied by falls – or at least slower growth – in part-time and temporary working and in self-employment will the labour market be signalling the need for higher interest rates.

"It also appears that house price inflation is beginning to ease. One lesson from the financial collapse is that the Bank of England needs to have regard to a wide range of prices in the economy, not just consumer prices. An asset price bubble is just as big a threat to economic stability as accelerating consumer prices.

"The more likely outcome in 2015 is that low headline inflation rates serve to lock in very low inflation expectations. And the risks appear to be tilted more in favour of deflation, which could be devastating for an economy with high levels of debt, rather than a surge in inflation.

"It is a moot point whether monetary policy or fiscal policy should be tightened first in the UK – should we have higher interest rates or deficit reduction? But there is nothing in the economic outlook to suggest that both need to be tightened simultaneously.

"We will not know the exact path that fiscal policy will take in 2015 and 2016 until after the general election, but at this point it seems likely that it will not deviate greatly from the path set out by George Osborne in his Autumn Statement. This implies a significant tightening of fiscal policy, which will reduce demand and growth.

"Low wage and price inflation appear to be the more likely outcome and when they are combined with the likelihood of a significant tightening of fiscal policy over the next two years, the case for keeping interest rates at their current level look compelling."

Notes to Editors

The full 1,400 word article by IPPR's chief economist is available from the IPPR press office and will be on www.leftfootforward.org on Monday 29 December 2014.

Contacts

24-26 Dec: Richard Darlington, 07525 481 602, r.darlington@ippr.org

27-29 Dec: Sofie Jenkinson, 07981 023 031, s.jenkinson@ippr.org

30 Dec–1 Jan: Tessa Evans, 07875 727 298, t.evans@ippr.org

2-4 Jan: Tim Finch, 07595 920899, t.finch@ippr.org