Wage Price Inflation Spiral Plus House Price Deflation Equals Stagflation

By: Nadeem_Walayat

Warnings of a further 40% hike in energy costs this year puts the Bank of England on high alert for a wage price spiral kicking in which will lead to much higher and prolonged inflation. The first signs of this are in the 14% pay hike agreed with the Shell subcontracted tanker haulers over 2 years at 7% per year which is more than double the current CPI inflation rate of 3.3%. The public sector unions are seizing this event to warn that recent pay agreements that cover the next 2 years will have to be negotiated in line with the rising cost of living signaling a 'Winter of Discontent' for Gordon Browns Labour government.

Inflation / Interest Rates

Before the shocking breakout in CPI inflation above 3% for May 2008, the Bank of England had originally penciled in the next cut in UK interest rates for July 2008 in support of the weakening housing market and economy. This is now not going to happen, the Bank of England had originally been of the opinion to ride out the inflation surge as a consequence of strong energy and food demand as well as China exporting inflation abroad by means of a stronger Yuan that had been artificially kept weak for many years. However now to address the danger of a wage / price spiral, Britains central bank may be forced into raising interest rates later this year to curb domestic wage / price inflation so all forecasts for 2009 are up in the air pending significant economic upheaval and clarification on monetary policy going forward.

The central bank is now clearly at loggerheads with the Brown Government as the Labour governments primary aim is to lay the groundwork for an election during 2009 for which the requirement is for a beginning economic environment funded by tax cuts and a surge in public spending. The Bank of England raising interest rates will throw a spanner in the works for this strategy and as I warned a few months ago, the government may infact force the Bank of England to abandon the inflation target of 2% so as to prevent the bank from raising interest rates ahead of a UK election. This strategy will definitely lead to stagflation which will require even harsher interest rate medicine and a much harder landing for the UK economy to bring the inflation genie back under control.

However the danger is that interest rate hikes may even worsen the inflation outlook as workers squeezed in real-terms will demand ever higher wage settlements and employers more willing to cave in to worker demands than in the past also more eager to follow the rest of the business sector in passing on the costs to the consumer thus igniting an even faster acceleration in an increasingly out of control wage price spiral. It is going to be a tough call for the Bank of England later this year of how best to defeat inflation without igniting the wage price spiral through its out actions!

The Market Oracle original interest rate forecast as of August / Sept 2007 is for a fall to 5% by Sept 08 has been fulfilled, in January 2008 the forecast was revised to 4.75% following the US Fed Panic Rate cuts. The forecast was on track to be achieved until the current wage price spiral fears surfaced which changes the interest rate dynamics going forward. The forecast for 2009 will follow in August 2008..

Housing Market Perfect Storm

The Halifax (Britains biggest mortgage bank) today finally woke up to the reality of the housing bear market by forecasting that UK house prices could fall by 9% this year as the property market grinds to a halt as mortgage evaporates. Less than 3 months ago the Halifax's Chief Economist was forecasting that UK house prices would NOT fall this year, which clearly implies wishful thinking on the mortgage banks part.

The UK housing market is not only heading for a sharp nominal house price decline which preliminary analysis suggests could be 25%, but a severe real terms fall of as much as 60% by the time of the eventual trough. Homeowners have yet to recognise the implications of a real-terms fall of 60% which implies a housing market depression for as long as 10 years before houses are again seen as an investment. The current housing bear market is into its 10th month and nominal house prices are increasingly expected to decline into 2011, or another 3 years.

The current housing market forecast for a 15% drop from August 2007 to August 2009 will receive a significant update by the 12 month anniversary as confirmation is sought on whether the wage price spiral will kick in as that will mean the difference between low growth during 2009 or a recession during 2009-2010, which will have a severe impact on interest rates and inflation and the housing market trend for several years.

Nominal House Price Forecast and Trend - Aug 07 to Aug 09

Real Inflation Adjusted House Price Forecast and Trend - Aug 07 to Aug 09

Analysis of the UK Housing Market:

By Nadeem Walayat

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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

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