The annual increase in the British Retail Consortium (BRC) shop price index – a measure of goods price inflation – jumped by two percentage points to 2.2% in December. The BRC index is a narrower measure than the official consumer price index for goods but this increase bodes ill for the December CPI report to be released on 19 January.

The chart compares the BRC indices for food and non-food goods with roughly-comparable CPI definitions. BRC food inflation tracks the CPI measure reasonably closely and climbed from an annual 2.8% to 3.7% in December. This represents an unfavourable surprise since the increase cannot be explained by the VAT effect – most food items are not VAT-able.

The annual change in the BRC non-food index rose from -1.2% to 1.4% in December, largely reversing a 2.8 percentage point decline in December 2008 due to the VAT cut. The annual change in the CPI for "non-energy industrial goods" fell by 2.2 percentage points in December 2008; a similar reversal would imply a rise from 1.3% to more than 3% last month.

Overall CPI inflation, including services as well as goods prices, fell from an annual 4.1% to 3.1% in December 2008. Higher BRC food inflation, the jump in the non-food measure and an unfavourable petrol price base effect suggest a similar-sized increase in December 2009. The forecast in an earlier post of a rise in annual CPI inflation from 1.9% in November to 2.6-2.7% last month may prove conservative.

Retail investors continued to pile into unit trusts and OEICs in November, buying a net £2.4 billion, according to Investment Management Association figures released today. Inflows are on course to reach a record £26 billion for 2009 as a whole – the previous highest annual total was £17.7 billion in 2000.

The November performance was particularly impressive given strong competition from National Savings, which attracted £2.8 billion, mostly into now-withdrawn "guaranteed growth and income bonds" offering a premium yield. Equity funds again enjoyed the strongest inflow (£930 million), followed by property (£420 million) and balanced (£250 million). Bond fund sales slumped to a 13-month low (£190 million), probably reflecting the National Savings effect.

Retail mutual fund inflows amounted to 1.2% of M4 excluding money holdings of "other financial corporations" in the six months to November. With investors reallocating portfolios away from cash, the sum of money growth and mutual fund flows is probably a better guide to liquidity support for the economy than M4 itself. This indicator – the green line in the chart – continues to revive, supporting recovery hopes. 

Investors are fearful that the coming election will produce a hung parliament and a weak minority government unable to tackle the gaping hole in the public finances.

They are right to be worried. The peculiarities of the electoral system mean that the Conservatives need to win a much larger share of the vote than Labour to obtain a majority of seats in the House of Commons. In addition, the economy – a key electoral battleground – is currently less unfavourable for Labour than is widely assumed.

The scale of the Conservative challenge is illustrated by “swingometer” calculators that project numbers of seats based on voting intentions. Assuming a uniform national swing, the Tories need to win at least 40% of the vote and lead Labour by 10 percentage points to achieve a Commons majority. Labour, by contrast, requires only a one percentage point advantage for an outright victory.

Recent polls have been volatile but on average show a narrowing of the Conservative lead since the autumn. The last four ICM polls since October, for example, have reported Tory/Labour differences of 17, 13, 11 and nine percentage points respectively.

Based on historical analysis of influences on voting intentions, Labour’s mini-revival is no fluke but reflects better economic trends. The Tory lead, moreover, could be cut further over the near term, magnifying worries about a hung parliament.

The boost, however, is likely to be temporary, with the economy turning against the government again from early 2010. This suggests that Labour’s chances of frustrating the Tories will diminish the longer an election is delayed.

With gross domestic product (GDP) yet to recover after a 6% plunge, it is controversial to claim that the economy has become less of drag for Labour. Voters, however, focus on influences on their personal finances rather than abstract concepts such as GDP.

Historically, support for the governing party relative to the main opposition has benefited from rises in pay growth and house price inflation while suffering when general inflation, interest rates and unemployment increase.
 
In early 2009, Labour support was eroded by a sharp rise in jobless numbers, widespread pay freezes and falling house prices. The damage, however, was limited by Bank of England interest rate cuts and a big decline in inflation, partly due to last year’s VAT reduction. More recently, the increase in unemployment has slowed sharply and house prices have recovered.

Based on current economic readings, the surprise is not that the Tory lead has eroded but that it remains at about 10 percentage points. The historical analysis predicts a much smaller gap, consistent with Labour being the largest party in a hung parliament.

On one view, Labour’s failure to rally by more reflects the party’s core unpopularity, implying dismal electoral prospects. The polls, however, may simply be reacting with a longer lag to economic changes, suggesting a further narrowing of the gap.

The trouble for Labour strategists is that the current economic boost is likely to prove short-lived. Rising inflation, in particular, threatens to undermine government support in early 2010.

The annual rate of change of the Retail Prices Index has already moved up from a low of minus 1.6% in June to plus 0.3% in November. It is likely to climb to about 4% by spring 2010 as a result of the VAT reversal and higher energy and housing costs.

Labour has a window of opportunity. The party’s strategists must aim to narrow the gap between its poll rating and current economic “fundamentals” and – if successful – call an early election. The arithmetic gives Labour a good chance of leading a minority government with only a modest further recovery in its support.

Delaying until May, however, is likely to prove fatal. Poor trade figures supposedly lost Harold Wilson the 1970 election. Could surging inflation do the same for Gordon Brown in 2010?
 
An edited version of this article appeared in today's Daily Mail.

November monetary statistics are consistent with an ongoing economic recovery. Corporate liquidity and mortgage approvals for house purchase continue to strengthen while narrow money is growing solidly. Broad money remains weak but this is of limited concern currently because low interest rates and reviving risk appetite have depressed the demand to hold money by households and financial institutions.

• Broad money (M4) holdings of private non-financial corporations (PNFCs) rose by 4.8% in the year to November – the fastest annual growth rate since February 2008. Real corporate money expansion is a leading indicator of business investment and hiring – see chart. Bank lending to PNFCs is down by 2.2% over the last year but rose in November, suggesting that credit demand is stabilising as the economy recovers.

• Household M4 growth slowed further to an annual 2.4% in November but this is likely to reflect a voluntary shift of funds into other savings vehicles. Mutual fund inflows probably remained strong in November – figures are released tomorrow – while National Savings attracted a bumper £2.8 billion, mostly into now-withdrawn "guaranteed growth bonds" offering a premium interest rate.

• The number of mortgage approvals for house purchase rose by a further 5% in November for a 123% annual gain. The housing recovery is focused on more expensive homes – the average value of morgages approved increased an annual 16% in November.

• Narrow money M1 rose by 12% annualised in the three months to November. A shift of cash into more liquid forms often precedes a rise in spending or financial investment; expressed differently, the M1 pick-up is consistent with an increase in the velocity of circulation of broad money.

• The Bank of England's preferred broad money aggregate – M4 excluding money holdings of "intermediate other financial corporations" – surged by 0.9% in November following declines of 0.6% and 0.9% in October and September. As explained last month, the volatility largely reflects the Bank's seasonal adjustment procedure for money holdings of "non-intermediate" financial firms.

• A sustained contraction in broad money would be concerning but recent weakness is explicable by portfolio shifts and has not prevented a recovery in corporate liquidity. Firmer credit trends should support M4 in early 2010 – banks expect stronger demand for business loans, house-purchase mortgages and unsecured consumer lending, according to last week's Credit Conditions Survey.