On Monday we learnt of the Chancellor's plans to give basic rate taxpayers (that's over 20 million people) £120, by increasing the tax free allowance to £600. This is to compensate the 5 million people who lost out as a result of the scrapping of the 10p tax rate. Overkill? Consider this.
Last month inflation achieved a 3% increase in prices compared to April 2007 or a 0.8% increase in prices compared to March 2008. Whenever the inflation rate hits 3% the Governor of the Bank of England has to write the Chancellor a letter telling him why, the only time he has done this previously was in 2007 when inflation hit 3.1% in March.
This means that even though last years inflation rate was high at 2.8% for April 2007, in April 2008 it is higher still at 3% even though this rate is ascertained by comparing prices to last year, at which point the level was also high. The inflation rate for the rest of the year will not be helped by a tax cut from 22 to 20p and a further tax cut of £120 resulting in an increase in the spending power of households and a resultant demand-pull level of inflation.
For now it seems the 3% level of inflation has been brought about by an increase in fuel and booze costs (i.e. cost-push inflation) so demand-pull inflation is not a major worry. However, it could become one by September, at which point the £120 comes into play, and if the Housing Ministers' fears come true, a slowdown in the housing market will need a reduction in the interest rate, to stave off an increase in negative equity properties. Any such increase in the interest rate will, however, have an impact on the inflation level as loans become cheaper, people spend more, demand-pull inflation kicks in.
In short, stagflation here we come, (unemployment increased by 14,000 in the first three months of this year). A very fine line is being tread.
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