The bubble that won't burst

The inflation figures do not lie. Once again the evidence shows that it is inflation, not deflation, that is the threat to recovery. A rise in bank rate in the autumn is becoming increasingly likely.

The Consumer Price Index, the one used by the Bank of England, persistently refuses to collapse despite all the forecasts of economists and in May it eased just 0.1% to 2.2% despite widespread expectations that it would at last be back to the 2% target.

It is true that higher taxes on tobacco and alcohol in the Budget put upward pressure on prices, though similar tax rises last year dropped out of the calculation and economists had naturally taken these changes into account in their forecasts.

It is no consolation that this is the lowest level for 16 months. After six months of recession and the reduction of the official interest rate to a measly 0.5%, one would have expected to be reaching the point where the Bank’s governor had to write to the Chancellor to explain why inflation was undershooting the 1%-3% target range.

One of the features of inflation since it peaked at 5% last year is that it has persistently refused to fall as rapidly as it rose in the days of soaring oil and food prices. Any supermarket shopper can tell you that the price of filling a trolley is still up by at least half from those glorious days when Tesco waged price cutting wars on its rivals.

The Retail Price Index is still in negative territory but even this more volatile calculation has ticked upwards, registering minus 1.1% in May compared with 1.2% in April. RPI has been artificially depressed by the collapse in mortgage rates over the past year but as more fixed term mortgages come up for renewal we shall see average mortgage rates, and the RPI, creeping back upwards.

As we have noted before, part of the reason for the slow reduction in inflation has been the sharp fall in sterling. That is being corrected, which will help to hold prices down over the coming months. So, too, will the fall in energy prices, although the recent bounceback in oil will probably prevent any further improvement in that score.

The massive increase in government borrowing, which will fuel inflation, is only just starting to feed through. With tax receipts in May slightly lower than in the same month last year, and spending 15% higher, public sector net borrowing reached £19.9 billion, the highest monthly figure so far.

Investors should therefore work on the basis that interest rates may rise in the autumn or, baring a dramatic turn of events, certainly early in the new year. This is a dampener for shares, as it will at last be marginally more worthwhile putting money into a savings account again rather than buy shares and chance a prolonged recession.

I believe such an effect on shares will, however, be muted. It is hard to see the Bank of England venturing more than one quarter point cut before year end and further increases will be held back until the economy shows real signs of picking up. Equally important, the true borrowing rate for companies, consumers and homebuyers is already much higher than the bank rate, which has become detached from economic reality.

Once again we have seen the FTSE 100 baulk above 4,400 points and I cannot see that level being breached decisively before September. This summer will present selective buying opportunities before the index gets a real chance to make progress in the run-up to Christmas.

Fred shreds again

Sir Fred Goodwin, former chief executive of Royal Bank of Scotland, has been shredding again and for once he has taken the scissors to his own money by giving up £4.7 million of his outrageously large pension pot.

Goodwin will not starve, as he will still receive £342,500 a year, but he has given up £212,500 a year, and that is £212,500 more than I expected him to forgo. Oddly enough, he agreed to this voluntary gesture only after an internal review at the bank exonerated him.

This sounds like a pragmatic deal between Goodwin and RBS chairman Sir Philip Hampton to draw a line under the matter. There was little point in dragging the issue out any longer. It was hard to see how any legal action would have achieved more.

The announcement of the deal on the same day that MPs published their expense claims will all the embarrassing details blacked out also looks to be a piece of pragmatism. Goodwin is seen in a more favourable light while the MPs have dug themselves further into the moat.