08/01/2013 18:01 GMT | Updated 10/03/2013 05:12 GMT

Inflationary Issue to Take Centre Stage in 2013

If you spent the Christmas and New Year period avoiding the news then don't worry, you haven't missed much. Outside of the US 'fiscal cliff' chatter the world of economics took a rest in December and with this is in mind we cannot see the Bank of England this week adjusting its current policy ahead of the 'stock-take' that next month's Inflation Report provides.

That's of course not to say that we don't expect the Monetary Policy Committee (MPC) to continue its quantitative easing program through 2013, taking the total amount purchased from its current level of £375bn towards £500bn by the end of the year. The minutes of the latest meeting did not explicitly call for further action but did note that business surveys pointed to little more than output subsistence in the latter part of last year. A continuation of those conditions alongside the paucity of consumer confidence, regardless of a spike in inflation, would see further loosening of monetary policy.

Inflation is going to be a big story in 2013 worldwide but especially for the UK. While the Bank of England's asset purchase program isn't in itself inflationary, the devaluation of sterling is. We think of imports and exports as goods and services, lorries and ships, planes and electronic transfers. Our largest import through 2013, because of the Bank's monetary policy, will be inflation.

Away from rent and mortgage payments, consumer expenditure is largely taken up by food and energy and, unfortunately, the prices for these are only going one way. All the larger utilities companies increased prices anywhere between 6% and 11% in Q4 while we have seen the Chairmen of two of the largest UK supermarkets, Sainsbury's and Waitrose warn about food prices.

Most of us will have moaned a bit about the weather in 2012, it was the second wettest on record after all. While for us city-dwellers that meant soggy socks and a continual need to replace the umbrella you left on the train, for apple farmers, for example, it meant the worst harvest in 15 years and a decline in production of some 45%. The lack of supply will cause prices to rise alongside whatever expensive imports our weaker sterling can garner.

I have been wary of calling for extra asset purchases from the Bank of England of late given our belief that they are susceptible to the law of diminishing marginal returns. Mark Carney, the new Bank of England Governor due to take over on July 1st, has suggested in the past that the Bank of England moves from an inflation targeting regime to one that targets nominal GDP.

Nominal GDP is simply GDP that hasn't seen adjusted for inflation. Targeting both would lessen the risk of knee-jerk reactions to spikes in inflation, such as the ECB's hike in rates in 2008 as the world economy started to circle the drain. With a nominal GDP target the ECB would have seen the slip in growth and may have been given pause. The risks are that, should the slowdown be as a result of supply issues and not one of demand, then the relative increase in inflation could see wobbles in the gilt markets and cause consumers' expectations of inflation to go bananas.

This is a risk that would likely see the chancellor oppose any change in plans as Carney takes the stage. The Bank of England needs shaking up, but we think that it may be too much for us Brits just yet.