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Pound Sterling inflation

Inflation keeps eating away at the Pound Sterling's value...

in Britain should count themselves lucky. The Pound Sterling only lost one-third of a penny to inflation in May 2007.

   Yes, the Pound Sterling's purchasing power lost 2.5p to inflation from a year earlier. Inflation over the last decade means that £1 spent on the High Street today would buy you 15% less than it bought in spring 1997.

Throw in mortgage repayments, local government taxes and buildings insurance, and the Pound Sterling has now lost one quarter of its value to inflation over the last decade. So says the old Retail Price Index.

But luckily for home-buyers and leveraged investors trying to get by using the Pound Sterling today, property expenses and indirect taxes just don't count anymore. Inflation in the cost of consumable goods and services is the only kind of inflation that the Bank of England worries about. And the CPI, a data series running for the decade now, just tiptoed further away from the record high inflation it recorded in March.

That means lucky old Mervyn King – governor of the Bank of England – can keep the lid on his fountain pen for another month. No open letters to the Chancellor are needed to explain away inflation this June, even if the Pound Sterling money supply is rising at 14% year on year.

"The UK's inflation rate fell to the lowest in seven months in May after utilities cut gas and electricity bills," as Bloomberg reports this morning. Cue the Pound Sterling to sell off on the currency markets – even though Dr. King himself was out on a jolly in Cardiff, Wales last night, talking tough about raising Pound Sterling interest rates.

"Our job," said Dr King of central banking, "is rather like taking part in a 'spot the ball' competition...'Spotting the shock' is a perpetual challenge for us. The shocks we have identified are the reasons we raised Bank Rate four times over the past year."

If Dr. King's looking for shocks, he's got plenty of reasons to jump at the moment. Total output in the UK has grown at an annualised rate of 3% for the last 18 months, as he notes nervously, "the longest run of stable output growth since 1997."

World GDP growth, meantime, has averaged 5% per year since 2003 – and while the flood of cheap labor into Britain should have "shocked" inflation to the downside, business failed to hire fast enough to depress higher wage claims, he goes on.

"Wider and cheaper availability of credit was a ‘shock’ that boosted spending," Dr. King adds – a man who's done more than most to make credit cheaper and more widely available – "thereby increasing the stock of money...and this will push up on inflation."

"Sharp rises in the prices of energy and food," Mervyn King says, "have squeezed spending on other goods and services, putting downward pressure on those prices. That is why measures of ‘core inflation’ that strip out certain prices can be highly misleading."

Finding a reason to ignore "core inflation" would prove lucky again for the UK's chief central banker. Consumer-price inflation rose 2.5% in May '07 compared with the same month last year, says the Office for National Statistics – a nice and benign deceleration from April's 2.8% rate of increase.

But so-called core inflation, excluding food, alcohol, energy and tobacco, accelerated to 1.9% from 1.8% – "matching the highest level since 1997," as Bloomberg reports.

You might wonder quite what's left in a cost-of-living index after you've stripped out food, booze, cigarettes, electricity, heating and petrol. But ignore those bills, and you'll get chance to ignore housing and fuel costs rising 9.1% year on year. Tobacco rose 6.3%. Getting drunk became 3.2% more expensive, even before the inflation that regular boozing can add to your drinks bill.

But outside the pubs, clubs and bars – where deflation might kick in when smoking is banned from the start of July – "the increase in core inflation is ongoing and that means inflation may go back up," reckons Alan Clarke, an economist at BNP Paribas in London. "We're still in a hiking environment, and not only in the UK."

The mere thought of higher global interest rates continues to spook the US bond market, meantime. The yield on 10-year Treasuries – the global benchmark for the price of money – broke above 5% for the first time in nearly a year earlier this month.

Will 5% or just above prove a worthwhile annual income for the coming decade? Washington is now looking to auction off $8 billion in new 10-year notes this week. The price offered by the big institutions might point the way for global interest rates from here.

Once you've bought a bond, remember, your yield is locked in – no matter what inflation does – and that's at best, too. At worst, the debtor goes bankrupt – or simply neglects to pay up. Sovereign governments never default, of course – Argentina, Russia, Mexico, Italy and most of the rest of the world excluded. That's why the 10-year US Treasury sets the benchmark for "risk free" returns.

How much risk is there in owning UK government bonds today? Unlike the United States bond market, UK gilt prices are so high, they point to lower interest rates from here.

Luckily for Gordon Brown, in other words, the City and Wall Street still love the Pound Sterling – even though it keeps abusing cash savers and destroying their wealth after tax and inflation.

Buy gold, short money...? When this bull market in "good luck" runs out, buying gold bullion outright might prove a wise strategy compared with buying fixed-income bonds.

Adrian Ash

Adrian Ash, BullionVault Gold News

Adrian Ash is director of research at BullionVault, the world-leading physical gold, silver and platinum market for private investors online. Formerly head of editorial at London's top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and he has now been researching and writing daily analysis of precious metals and the wider financial markets for over 20 years. A frequent guest on BBC radio and television, Adrian is regularly quoted by the Financial Times, MarketWatch and many other respected news outlets, and his views from inside the bullion market have been sought by the Economist magazine, CNBC, Bloomberg, Germany's Handelsblatt and FAZ, plus Italy's Il Sole 24 Ore.

See the full archive of Adrian Ash articles on GoldNews.

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