UK Inflation Figures disappoint again for April 2010

We come today to that time of the month when the indices for inflation in the UK are due. They are particularly significant over this period of time because we have several issues at play. Firstly inflation as measured by the Consumer Price Index (CPI) is not only over its target it is more than 1% over its target. Secondly our body for controlling inflation the Monetary Policy Committee made a mistake when assessing what inflation would be now. I wrote in my article of the 13th May  about what the MPC was forecasting in its May 2009 quarterly inflation report for what it felt inflation would be now. In case you are wondering it was approximately 1%, so they were out by some margin. Thirdly our previous targeted index of inflation RPI-X (the all items RPI excluding mortgage interest payments)  is even more over its target than the current one. Thus if you were to look at the situation in terms of this you would be even more worried about inflationary trends in the UK.

Bank of England Monetary Policy Committee Forecasting Record

In my article of the 13th May I concluded the following

You see they set their monetary policy based on this and in May 2009 they were expecting an inflation undershoot when in fact we have an inflation overshoot. So policy has been set inappropriately.

Thus one might reasonably conclude that current policy which involves a base rate of 0.5% and a stock of some £200 billion of Quantitative Easing has been too accommodative. We have an extraordinary amount of monetary relaxation in our economy and it has been too much. The MPC’ s apparent terror of the possibility of any disinflation led it too a succession of unprecedented base rate cuts followed by an equally unprecedented experiment in Quantitative Easing.The problem is that their policy response of panic and terror when faced with the possibility of disinflation is not matched even remotely by their response to inflation over target. Indeed according to their latest quarterly inflation report published this month they say (without apparent irony or embarrassment).

Inflation has already been above the target for all but six out of the past 30 months for which data have been released

Looked at like that I think that it is not unreasonable to conclude that either they are not worried about inflation and are aiming for a target they are not telling or that they are worried but that their record involves policy mistakes. Or of course some combination of the two.

Did anybody else do better?

I cannot help in data back to early 2009 as I had not started this blog at that time but I have found and interesting and I think revealing source. The Member of Parliament Frank Field,someone I have respect for because of his work in and commitment to the issues around poverty, wrote the following on the 29th March 2009.

A month ago, the experts were predicting an era of deflation (disinflation) once the retail price index (RPI) was published. I cast doubt then, and do so now, on this analysis. The danger for the British economy is inflation, not deflation.

The British economy is in a big enough mess without policymakers fighting the deflation dragon, which shows not much sign of yet appearing on the scene. The 30% collapse in sterling has still to be fully registered as an upward movement in these measurements. And the government has embarked on a printing money policy, which can only lead to enormous inflationary pressures.

It is inflation, not deflation, that is still the public enemy.

Rather on the ball wasn’t he? Frank Field for Governor of the Bank of England?

Well if he had stuck to those views he would have done a better job than the current incumbent Mervyn King. You see my argument with current policy revolves around things which were known back when interest rates were being slashed and the QE experiment began. For example as Frank Field states there had been a 30% reduction in sterling’s exchange rate which has predictable effects on inflation and there had been reports on other countries experiences (mostly Japan) which predicted how QE was likely to turn out. I do not expect Frank to have known this but I do expect the MPC to have done so. Yet they still persisted in a set of policy mistakes which have led us here.

Today’s figures for inflation

These are rather shocking and somewhat disturbing.  According to the Office for National Statistics Consumer Price Inflation is now 3.7% and has risen 0.6% on a month on month basis. Ordinary RPI  has risen by 1% on a month on month basis and is now 5.3%. RPI-X (our old targeted measure) has also risen by 1% on a month on month basis and is now 5.4%. Things are going from bad to worse.

What has caused this?

This months rises in inflation have several factors behind them. Clothing and footwear,food and beverages and tobacco and alcohol were the main factors at play here. The RPI figures were also affected by a rise in their housing component mainly because they were compared with (falling) mortgage costs from a year ago. However we do not get a breakdown for RPI-X which of course does not include the mortgage component as if you do the maths and compare differences the changes do not quite add up! You might consider that to be a metaphor for UK inflation policy.

What will happen now?

The Governor of the Bank of England will have to write a new explanatory letter to the new Chancellor George Osbourne as the one from February has a 3 month lifespan. Let us remind ourselves of what was written in February.

“This is the third episode when inflation has moved above the target by more than one percentage point. As was the case on previous occasions, the Committee expects this to be a temporary deviation of inflation from the target”

If I was Chancellor I would write back and request a definition of the word temporary….

I do not expect much to have been learnt because in this months inflation report we got

As these temporary effects on inflation wane, downward pressure from the persistent margin of spare capacity is likely to cause inflation to fall below the target for much of the forecast period. But the pace and extent of that moderation in inflation are highly uncertain.

The MPC’s faith in output gap theory appears to remain regardless of the evidence that it is not working.

Our old inflation target is telling us something

If you take what was our inflation target RPI-X I would like to point out that it is now 5.4% and also that its targeted level was 2.5%. So it is 2.9% over its target (my emphasis). This is really quite shocking on two counts. Firstly as I wrote in my technical point of the 20th April there was a clear relaxation of inflation targeting when we switched from this to CPI as a target. But secondly we are seeing how much our guardians are willing to let this measure run over target. Just think of 5.4% inflation and compare it with the (bad enough) 3.7% that the newspaper headlines will be full of.

Our current inflation measure is 1.7% over target and our previous measure is 2.9% over target. Seeing as they are supposed to be measuring the same concept this is quite a difference!

What can we expect going forwards?

There are several factors at play here.

1. Our producer price figures are unfortunately even worse than our consumer price indices. Out put prices for April rose by 5.7% on a year on year basis and input prices rose by 13.1%. So there is more pressure in the system.

2. Our exchange rate has fallen against the US dollar recently and this is likely to add to inflationary pressures. For example our effective exchange rate closed at just under 78 on the 14th May which is where it was on the 19th April but over that period we fell against the US dollar from 1.53 to 1.455. We started 2010 at 1.61 versus the US dollar.This is important as many commodities including oil are priced in US dollars.The corollary of this is also that our exports will be less competitive as we must have risen against other currencies. This is the nightmare combination of exchange rate moves for the UK.

3. Against this there may be some relief from the recent fall in the oil price. This is hard to be precise about because the two measures Brent crude and WTI crude appear to have decoupled which is odd! But there has been a fall.

Comment

To my mind we have two problems. The first is that we have a clear inflation overshoot. The second is that our supposed guardian against such things the Monetary Policy Committee has not done its job and is failing in its task. I have given it some leeway because we went through difficult times but it has now used that up and some. But in terms of inflation its credibility is at best somewhat damaged and at worst gone. There has been a clear asymmetry between their moves when inflation is expected by them to be below target (panic) and when they expect it to be above target (complacency) in my view.

If one mentally takes a step back the overshoot recorded above is even more extraordinary when you consider that we have just gone through a year where economic output dropped by almost 5%. I am afraid this makes the policy mistake by the MPC even worse. I wrote at the time of the election debate the following as questions for the candidates.

1. How do you plan to make the MPC independent again?

2. What reforms do you intend to make to the MPC to help prevent it making more policy errors in future?

I would now add that as we are likely to get criteria for circumstances of gross neglect when a Member of Parliament can be deselected I feel that we need something similar as a check against the power of the MPC. All good systems need checks and balances and their erformance has exhausted any goodwill they deserve.

Looking further forwards there is another danger to inflation and that is a rise in Value Added Tax to 20%. Should it happen (and it looks very likely) then inflation will get another boost…

 

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14 thoughts on “UK Inflation Figures disappoint again for April 2010

  1. Inflation is the easier political target. It is paid for by creditors, including savers. They traditionally have little political voice in the UK. Deflation, by contrast, hits high profile debtors and of course that includes the government, already over borrowed to the hilt, along with a good chunk of the UK electorate.
    What we are seeing now is a relaxed attitude towards inflation, bordering on policy to inflate. Taken with the confusing indices that we use and a chunky Sterling devaluation that is still feeding through into our output pricing, I think I detect a general desire to do very little to prevent inflation.
    After all, it is a tradition in the UK to use inflation to get out of awkward corners! What is not so traditional is to combine ultra-low interest rates with accelerating inflation.

  2. Like you and many others who take a rational/critical look at data and events, it has been obvious for a long time that the result of their policy has to be inflationary. I cannot accept their response as simple incompetence. They must be reliving history and deliberately using inflation to destroy asset values and hence accelerate deficit reduction, when coupled with imposed wage restraint and tax rises from the politicians.

    So these policy mistakes ARE the policy and deliberately so, just as exchange rate fall should promote exports (the problem being that only 17% of GDP actually makes anything, unlike the 40% in 1974). Their error may simply be in dishonesty in communication, falling into the “we know best”, expert syndrome.

    • But, A.P.Trayes, the MPC was given a sole clearly defined remit. That was an exceedingly simple job, with a relatively high rate of reward. It is not possible for employees who have been given a simple defined task to decide to do the opposite of what they have been instructed to do, because they think they know best, and still remain so employed.

      If the members of the MPC cannot achieve their simple defined task then why is it needed any longer? In these days when austerity is the necessary order of the day, surely if the same old political policy of inflating away government debt by debauching the currency is to be used, that is as it has always been the decision of the current government – not of the MPC. They have never been authorised to make such a decision, and the continued payment to the individual members is an unnecessary and purposeless luxury which we can no longer afford with the required cuts of expenditure.

      As Shaun makes clear today, the MPC has dismally failed – not just in the short term, but continuously. It was supposedly formed by Brown solely to control inflation independently, to prevent governments doing what they have continuously done as you observe – debauching the currency to help pay for their profligacy. If the continued presence of the MPC now makes no difference, then it is superfluous and should be abolished, with no further payments from Public Funds to the members who have failed to do the job they were specifically paid to do?

      • Drf: “if the same old political policy of inflating away government debt by debauching the currency is to be used, that is as it has always been the decision of the current government – not of the MPC. They have never been authorised to make such a decision”

        Possibly they were authorised to make these decisions when their remit was expanded to ‘Maintaining Economic Stability’ or words to that effect. I’m not sure how narrowly that remit was defined. Most would assume it means ‘don’t allow asset bubbles to grow’ but that would imply a change of inflation indicator, which was not forthcoming. So it seems that the new remit for the BoE is wider than that.

        Their eye will be on the real interest rate on gilts, and very little else at the moment.

        In five years time Mervyn “Gordon Browns appointee” King will be fired for failing to bring inflation down below 6%-12% (who knows?) and in 8 years time the BoE will finally raise interest rates above inflation.

        Why else was Mervyn King left in the job, other than to be a scapegoat for the inflation he is being leaned on to allow?

        I believe the current language being used by the BoE about output gaps means simply “We have very low growth, so the Bank only has to pull the levers and inflation will respond immediately.”

  3. Shaun I was wondering whether you can be contacted directly (email etc), or if you prefer to keep everything via the comments attached to your postings?

    With respect to this posting and others, you seem to be absolutely determined to give the MPC, the gov’t etc the fullest benefit of the doubt. This politeness and deference makes your blog a very civil thing to read, even when the balance of probabilities might point to explanations that involve less competence or less benign motivations. I for one enjoy your writing style.

    I do find it difficult to understand how anything other than inflation (understood in the sense of a decline in a currency’s value) can possibly happen – in the US, in the UK and in the EU. (And this concerns me because when I develop 100% conviction on a particular idea and am completely unable to see or understand the contrary position as credible, I’ve generally not had good experiences!!)

    While I am no unreformed Austrian there is more than a little of their thinking colouring of my views. I just can’t see how sustained creation of currency and credit significantly north of the growth of the underlying economy can work its way through the system as anything but inflation. If we want to quibble about the mechanism and timing, all I know is that I don’t know; things usually seem to take longer, with more perverse twists and turns along the way than one can possibly forecast, and somehow end up doing more damage than even a reasonable pessimist might suggest.

    • Thank you for the compliment.

      I will send you my email address if you wish to contact me on something which is not on the blog list/subjects etc.. I thought that there was an email address on this blog and will check. It is not in fact my personal one because in a triumph for shaunkind I managed to spell notayesmanseconomics incorrectly when I started up and my email address was logged into that and cannot be changed…..

    • (as I was composing this I received an email from Shaun with his address – thanks!)

      On the front page of the blog the blurb Should one or all of these be of interest then please contact me via this website. suggests that if I look around a bit I ought to be able to find an email address for you, but so far I’ve been stumped. I’m not sure if as the blog owner you are able to see the email address that I supply every time I post, or if I should post it in a future comment.

      What prompted my request is that there were several minor typos in your posting, which seemed too trivial to mention and dilute the serious comments and yet bothersome enough to be worth fixing e.g. while any disinflation led it too a succession would grate under any circumstance it’s even worse on a well-written blog! Rest assured though that it is not only for dirty little pedantry that I was interested in your email details, I also expect to be in London in about a month’s time and was thinking I might summon up the cheek to invite you out for a beer to say “thanks!” for writing such a sound blog.

      With this much administrivia, might as well keep this comment entirely economics-free and close with this comment on comments: If there is a way with WordPress to preview and/or edit comments, I sure wish I could figure it out!!!

  4. The MPC has not failed it has succeeded. There is clearly a plan across all central banks to create inflation though excess liquidity. The only reason they do not enunciate this policy it to try to keep the wool over the eyes of these nations creditors eg china and the petro nations.

    Sorry I had to let the conspiracy theorist have a run around the park.

  5. Perhaps they could now take a little pity on savers and put up interest rates by a smidgin (next month) so as to prevent a pensioners’ revolt!

    We’d better all start growing our own food and collecting firewood too so we can manage on our diminishing (in purchasing power) incomes.

  6. Jonathan Treloar, “Possibly they were authorised to make these decisions when their remit was expanded to ‘Maintaining Economic Stability’ or words to that effect. I’m not sure how narrowly that remit was defined.”

    I have not been able to find any such expansion of the remit of the MPC as you claim to have been implemented. Perhaps you will be kind enough to point me to where such an extension is defined in written form? In any case, if you are not sure how narrowly this remit was redefined, how can you suggest that to inflate away government debt by debauching the currency was authorised in that as part of the expanded remit? I suspect you like a number of others may be confusing what is stated on the BoE web-site as being part of the responsibilities of the corporate BoE rather than of the MPC per se, who have a much more limited remit, which is defined in a specific document which is included on the BoE web-site..

    I still believe that as with all other tasks, “success” or “failure” can only be recognised in terms of achieving the objectives stated in the remit for that task. It is a common error made for example in the fields of Programme and Project management; if the objectives for success are not adequately defined in written form. How can you then know when or whether you have achieved them or not?

    • DRF: Having done my homework I have to admit you are right.

      The Asset Purchase Facility is under the control of the MPC, not the Financial Stability Commitee, and the new powers given to the Bank that I was thinking of were not part of the Banking Act 2009 but were authorised by the chancellor in letters to the bank in Jan 2009.

      • Thanks Jonathan. It is not a matter of being right, but rather of judging the performance of the MPC against their remit. Whichever way you look at it, it seems to me, as Shaun implied today, that they have dismally failed in fulfilling their remit.

  7. Economists being pretty bad at economic forecasting is not news. The Office for Budget Responsibility take note.

    • True enough
      My problem with the situation is that many people in authority do not seem to learn from their mistakes and of course if you do not then you are likely to repeat them. This particularly applies to UK Inflation over the past 18 months I think..

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