Yesterday was a day for meetings of central banks with both the Bank of England and the European Central Banks (ECB) announcing the results of their latest meetings. Little was expected and little was provided with policy remaining unchanged. In addition the President of the ECB was quite tight-lipped when interviewed afterwards on questions such as government bond buying. There is the occasional rumour going round the markets that the ECB may cut rates further (in spite of the fact it has said it sees 1% as a floor) and this got some support from the comments of “Dr. Doom” Nouriel Roubini. He feels that the ECB should cut its official interest rate to zero and expand its government bond purchases. As to its latest financial backstop he feels that 750 billion Euros may not be enough so he may also have contributed to the words of European Union President Mr. Van Rompuy which were quoted in yesterdays comments section.
As to equity markets well we got another triple-digit day with the Dow Jones closing up an extraordinary 273 points on very little news.This is now 23 days out of the last 29 with triple-digit moves. It looked like a short squeeze to me but some attributed it to an improved export performance by China. The problem for their logic is that Chinese inflation figures out last night show signs of over-heating being above target at 3.1% for consumer prices, so shouldn’t we now retrace our steps?
UK Inflation and Inflationary Expectations
The UK has had a period this year where inflation has exceeded its official target for each month of this year, in fact it has been more than one per cent over each month. The Bank of England has several times said that inflationary expectations remain low as part of its campaign to persuade people that inflation is and will be only a temporary phenomenon. However Barclays Bank carry out their own measures of inflationary expectations which was published yesterday. It tells a different story.
Barclays Bank said its BASIX survey of inflation expectations, which it has been compiling since 1986 (giving it a reasonable track record), recorded an average expectation for inflation in May 2011 of 3.4 per cent and this is 0.6 % points higher than in the first three months of this year. Indeed their report also publishes figures for what people think inflation will be in two years time and this was 3.8%, which was also up 0.6% on the previous survey and the largest upward rise in expectations since the first quarter of 1995. At the five-year horizon, inflation expectations lifted to 4.1% from 3.8% in the previous quarter.So not only rising inflationary expectations but ones which are sustained going forwards. This is exactly what the Monetary Policy Committee will not want to hear. They will not be able to say in future that this index remains below its series averages as the did in their last Quarterly Inflation Report.
Also the Bank of England has today published the results of its quarterly survey on U.K. consumers’ expectations on price increases in the next 12 months which was compiled between May 13 and 18. It showed inflationary expectations rising to their highest level since August 2008 with predictions of inflation of 3.3 % in a year’s time. This compares with expectations for an increase of 2.5 % when the survey was last compiled in February
Today’s Producer Price Figures
Regular readers will know that one of the factors driving the poor UK Consumer inflation figures has been both input and output producer price figures. These are important because they give a signal for inflationary trends at the beginning of the price chain. They are also significant because the figures have been so high recently. For example input price inflation was in double figures (10.5% and 13.1%) in March and April 2010.
Today’s figures show output price or what is called ”factory gate” annual inflation for all manufactured products rose 5.7% in in May which was up 0.3% on a month on month basis. These price rises reflected price rises in most product groups especially petroleum, and alcohol products. These rises were partially offset by a fall in the price of other manufactured products.
The input price index for materials and fuels purchased by manufacturing industry rose 11.2 % in the year to May but fell 0.6 per cent on a month on month basis between April and May. The fall in the input index between April and May mainly reflected a fall in the price of crude oil, partially offset by price rises of chemical, and home produced food products.
These are bad numbers and continue what is a very poor trend. There is a small glimmer of hope from the fall in month on month input inflation but even with the fall the rate of annual rate of inflation remains in double figures. Again we have a marginal fall in output inflation on an annual basis but we remain well above 5%. As these are signs of inflation in our economic system they present a considerable challenge to the economic policy of the Monetary Policy Committee.
These are a poor set of figures and survey results. For example input price inflation has been in double figures for three months now indicating that there is further inflationary pressure at the beginning of the UK price chain. This in itself poses a challenge to the MPC view that the current rise in inflation is a “blip”. Now we see inflationary expectations as measured by Barclays Bank and the Bank of England itself rising. I think that you have to ask now, what would make our supposed inflation watchdog actually raise interest rates?
Recently Adam Posen a member of the UK Monetary Policy Committee gave a lecture on the Japanese “lost decade” at the LSE. Regular readers will be aware that this is an area I study and write about but I found a note to the speech to be potentially rather revealing as Mr.Posen refers to the UK experience.
No, I am not happy that UK CPI inflation is currently overshooting the Bank’s government given inflation target. As I have said in the press of late, if this proves to be other than temporary factors at work, the MPC should take action. But I’d certainly rather have us temporarily overshooting by around 1% than facing oncoming deflation.
As I have written many times asymmetry is very dangerous and one might also refer that such views and opinions blatantly contradict the stated policy aims of the Bank of England and the Monetary Policy Committee. Also I think it is time he and the other committee members are challenged on the meaning of the word “temporary”.