Best Financial Markets Analysis Article UK Producer Price inflation soared in May to 8.6% for the price of output of manufactured goods to levels not seen since the early 1980's stagflationary recession. The trend not only signals a halt to further rate cuts but increasingly the expectations are that despite sharply lower economic growth, UK interest rates will be forced higher as inflationary forces make themselves visible in the CPI data that currently stands at the Bank of England's upper limit of 3%.

The deteriorating situation is a clear warning that the UK is heading fast towards stagflation as costs are now being passed onto the consumer rather than absorbed by manufacturers. This coupled with deflation in the housing market that is leading to sharply slowing economic activity implies that the UK is entering into stagflation.

Fueling the rise in producer output prices are soaring input prices rising to stagflationary high of 28.1%, a rise of 3.7% for just the month of May. The inflationary surge is as a consequence of the tripling of crude oil prices during the past 2 years. The expectation is that the ongoing spike in oil prices towards $140 has yet to make itself visible in the price indices and therefore inflation is expected to continue to soar higher in the coming months, where the Input prices will feed into output prices that will feed into the RPI and CPI inflation measures. The doomsday scenario remains for crude oil spiking to $200, the consequences of which would imply double digit inflation as the wage price spiral kicks into gear.

For more than a decade the UK has relied on ever cheaper Chinese goods many of which are assembled in Britain to effectively import Chinese deflation and thereby keep UK inflation low. Now, clearly that trend has reversed as China 's CPI inflation running at 7.7% has the effect of exporting inflation abroad. Therefore the UK is being hit by a double whammy of soaring input prices and soaring imported goods prices.

This implies a sharply higher trend for CPI inflation towards and possibly through 4%. However the real rate of UK inflation as a consequence of changes to the way official inflation is calculated over the last two decades is more accurately reflected in RPI +1%. Therefore RPI rising to and possibly above 5% could see a real inflation rate at above 6%, and therefore real negative UK interest rates of more than -1%.

The consequences of negative real interest rates will be for a further sharp fall in the British Pound which has already fallen from Euro 1.50 to Euro 1.25, or 17%. In such an environment of negative real interest rates the British Pound is expected to trend towards parity against the Euro as the ECB has signaled a more hawkish tone by implying european Interest rates are headed higher.

By Nadeem Walayat

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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