Inflation, inflation; Eating the Pudding Of Quantitative Easing (QE)

Central Banks have been in love with low rates for very long, too long one might argue. The economy needed it, they said. Everyone was better off that way, they said. But how can money that is technically worth nothing, have value in an economy?

The decade long 0.5% rate economy

Low rates allow (ed) governments, corporates and to a lesser extent households to borrow money for near to nothing, which on paper sounded great. But at the same time low rates make a mush of our savings and although inflation for a long time did not ‘exist’ in our daily lives, the easy money flow did create inflation, perhaps not in the supermarket, but certainly in the stock- and housing markets. Consumer prices were low as abundant cheap labour (China and South-East Asia) and quantitative easing (QE) kept prices down and consumers happy. Quantitative easing in essence means that Central Banks keep pumping money into the system, creating enormous liquidity and making money worth nothing much, leading consumers to spend it, not save it. The buy-to-let boom and the stock market bull run since 2009? Both directly linked to QE and the low-rate economy it kept going.

Where interest rates always so low? No

In the past 14 years or so, interest rates have been much higher, and at times significantly higher than the official 2% rate of inflation. And many people liked it. The idea was that you could put your savings in a bank account and receive 4 to 5% annual interest on it. No risk, no fretting about bond or stocks, just a plain old interest account. That PAID.

On July 5th 2007, the base rate of the Bank of England was 5.75%. By March 2009, only 20 months later, following the Great Crisis, the rate was lowered to 0.50%. Inflation meanwhile was always steady (according to the ONS) around 2%. How can the same level of inflation warrant such different levels of interest rates? This is not what the theory teaches us. But, nevertheless, rates never even came over 1% again until this day. Zero rates became the new normal, even when they were not justified. We were addicted to them.

The Pandemic end to low consumer prices

The pandemic quickly changed the stationary rate of inflation. Intra- and post pandemic there was such a supply-demand imbalance for goods and services that prices started to go up for everything. Today, simply everyone must notice how much higher prices are than they were a few months ago. From buying a coffee, to cereals, to your Deliveroo indulgence or taking an Uber, prices bite. Did anyone notice that a simple croissant now costs £2.25? Pretty crazy.

Inflation at an all-time high: can Central Banks save the day?

Now that inflation crept up, too much and too fast, Central Banks need to act. The Bank of England has started to decelerate the quantitative easing and has hiked rates from 0.25% to 0.75% recently. More rate hikes in the near future should reduce demand for goods and over time this should bring inflation down. But reduced consumer spending also reduces economic growth, so how can Central Banks balance that? Or have they been so busy with QE for years that they are now too late to get back on track without triggering a recession?

Inflation and you

What does inflation mean to you? When prices rise officially by 7.5%, but, are really going up by something like 20-30% and your allowance or your salary does not rise by more than 2-3%, something must change as you are beginning to be out of pocket? Should Central Banks raise rates to the 2007 level of 5.75%? It seems very unlikely they will or can at this late stage without creating a shock. Is the very high post-pandemic inflation in that case just a big price reset that takes getting used to?

But rates below 1% and official inflation at 7.5% is unsustainable. Inflation might be that more sticky than we are hoping for. The past decade of QE has served up a pudding we do not like and- besides - can’t afford but must eat.

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