The economy has entered an uncertain period. Growth is slowing and the continued stream of closures and difficulties in the technology sector show how directly we are being affected by the US slowdown. It is a concern that inflationary pressures remain. The latest consumer price index (CPI) figures show a small increase in the annual rate to 5.4 per cent in March from 5.3 per cent the previous month. More worryingly, demands for sizeable wage increases are emerging across the economy and fuelling industrial unrest. The danger is that an inflationary psychology becomes embedded in the economy and begins to undermine our competitiveness, at a time when the international outlook is weakening.
The latest inflation figures are not, in themselves, a cause for alarm. The March increase was unexpected, but last month's figures are still likely to be the peak for the year. The consumer price inflation rate has fallen from a peak of seven per cent last November and will probably average four to 4.5 per cent this year. Some of the increase last month was in food prices, due in part to the food and mouth crisis.
The more worrying inflationary factors are not directly reflected in the CPI. In particular, there can be no doubt that wage growth has accelerated sharply. Worryingly, demands for sharp increases continue to emerge across the economy. In many cases the increases granted in recent months reflect higher productivity; meanwhile many economists argue, with some justification, that increasing wages will act as a badly-needed brake on the economy , helping to slow it from the unsustainable growth rates of recent years.
The danger, however, is that higher inflation becomes embedded in the economy. The level of business profitability in the booming economy of 2000 may have justified healthy wage increases for employees, who deserve to share in business success in the good times. The difficulty now is adjusting expectations as the economy slows. If house prices continue to rise, and the CPI does not ease back, pressure will remain for rapidly increasing wages, in turn fuelling consumer demand and perpetuating the inflationary cycle.
Wider use of profit and gain-sharing across the economy would help to mitigate these risks. However, progress in this area has been limited; in the private sector many companies have been slow to introduce these schemes, while in the public sector mechanisms to allow some kind of link between productivity and pay are only starting to be developed.
As we are now members of a single currency area, the exchange rate of the pound can no longer adjust independently to act as a shock absorber for the economy, nor can we unilaterally change our interest rates. This means that any sustained loss of competitiveness will eventually feed through to slower growth and lower employment. Worries about the outlook for the economy would be considerably eased if international conditions improved. To this end it is a pity that the European Central Bank did not cut interest rates this week to help spur European growth. Lower rates might not help to control inflationary pressures here, of course, but they would help to support the euro zone economy.