Inflation, rather than sleaze, could kill off Boris Johnson’s government

Fragile business and consumer confidence, more expensive mortgages, higher house prices and rents, inflation and stagnant living standards tend to make governments unpopular

Not for 30 years has inflation been much of a political issue in Britain. Aside from the odd sharp hike in the price of petrol and some food price inflation around the time of the financial crisis, inflation has stayed at lowish levels for so long that not many people can actually recall the alarming and disrupting effects of accelerating inflation. It shreds savings, obviously, distorts economic decisions and generally saps business and consumer confidence. In the race between wages, pensions and benefits on the one side, and the cost of living on the other, it is usually inflation that wins out.

We must now consider all these factors, following news that inflation in the UK climbed sharply to 4.2 per cent in October, its highest rate for almost a decade.

It all tends to go wrong when inflation gets into the system, like a bad cold turning into pneumonia. When there’s a wage-price spiral – costs go up and workers demand more pay – that’s when inflation has become endemic, and harder to tame. The signs on that are mixed, but the otherwise good news about the success of the furlough scheme and relatively low unemployment is tempered by suggestions that some of the conditions for such a spiral may be building up. There have certainly been some marked upward adjustments in pay rates in certain occupations (though not too much should be made of such sectoral movements).

The “cure” for inflation since about the 1970s, the last time it really took off, is tighter monetary policy: broadly higher interest rates, lower government borrowing and a squeeze on demand. And so there is much talk about the Bank of England raising rates now to choke off demand, making it harder for firms to raise prices and more difficult for workers to win pay rises. Then, it’s hoped, inflation will subside. Indeed the very threat of higher rates will have a chilling psychological effect on inflation.

If we’re lucky, then rates – mortgage bills and the cost of business finance, principally – won’t need to go up much to have the desired effect. If not, it’s because the problems are much worse. Or to do with shortages of labour and broken supply chains post Covid and post Brexit. A much harsher squeeze will then be needed.

Politically, the government can’t really win either way. If nothing is done about inflation, it will surely accelerate and make people poorer (though the rich, who tend to own substantial “real” assets, such as property, land and shares, are less affected). If the Bank has to push rates far higher – back to the kind of levels once thought normal, say four per cent or more – then we’ll also feel the squeeze. Businesses will go bust, jobs will be lost and people will again be poorer.

Fragile business and consumer confidence, more expensive mortgages, higher house prices and rents, inflation and stagnant living standards tend to make governments unpopular, and things are set to get worse. Uniquely among the major economies, the UK has increased barriers to trade with its largest markets, which is already hampering the post-Covid recovery. It will also depress private sector investment, and thus productivity and wage rises in the coming years. As recent news on HS2 and “levelling up” make clear, the government’s infrastructure spending splurge seems to be running out of momentum almost before it’s started. That, too, will make life tougher, especially in the red wall seats the Tories made such extravagant promises to.

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Things will get worse before they get better. The Budget has scheduled in some big tax rises, and the next Ofgem gas price review is also due in the Spring. By then, interest rates will almost certainly be up as well. Part of the blame will naturally fall on the Bank of England, which was one of the political benefits of giving it its operational independence back in 1997. But Boris Johnson’s government will still have to take its share of responsibility. A further prolonged period of Conservative unpopularity will inevitably follow – which was how the polls used to react to such economic trends back when inflation was last a central issue in British politics.

It’s probably also true that monetary policy may not be the best way to treat the current bout of inflation. This is because squeezing demand and taking money out of the economy only really works when an economy is classically overheating – a consumer boom with lots of new money chasing the same number of goods. What we have now is an unusual supply-driven push in inflation – the same level of demand but a smaller number of goods. Or, as the Governor of the Bank Andrew Bailey put it so succinctly, raising interest rates won’t provide more gas or semiconductors, or, indeed, more workers. In those circumstances, basically using the wrong tools for the job, you’d have to jack up interest rates to punitive levels to choke off a bad case of inflation, threatening recession.

That’s a gloomy look forward, but something like that sense of economic malaise could easily infect the economy and, more to the political point, add to the impression of a floundering, rudderless, incompetent, complacent government that has been in power for too long and doesn’t have an economic plan.

Inflation, rather than sleaze, could kill off Boris Johnson’s government and his party.