Inflation figures for May 2010 are still somewhat disappointing

Yesterday in some respects was a milestone for the UK as the Office for Budget Responsibility published its first set of forecasts. I have some more thoughts and analysis of this subject below. However internationally there was some news as Moody’s downgraded Greece’s financial rating by four notches from A3 to Ba1. I had two initial thoughts.Why now? followed quickly by do try to keep up with current events ratings agencies. However I then remembered that the IMF has an assessment team in Greece this week so Moody’s are most likely afraid of what it might uncover. Also Spanish debt markets were under pressure again yesterday a subject which will not go away. I will return to these subjects again but after a further review of the OBR today is the day for the UK’s inflation indices.

Further analysis of the Office for Budget Responsibility’s Report

After looking at its report again I thought that in many peoples minds one question would come up.

How did the OBR reduce growth forecasts and simultaneously reduce the deficit?

At first sight this appears to be outright financial alchemy as reducing growth would raise estimates of the deficit all other things remaining the same, however it is more complicated than that.As well as the reduction in estimates of future economic growth the OBR made some other assumptions which went in the opposite direction. These were.

1.The OBR forecasts assume that the share of VAT revenues that the Government will collect will remain constant over time as opposed to decreasing, as Chancellor Darling had cautiously assumed . In other words VAT tax evasion will not increase.

2.The OBR believes that public spending in 2010–11 will be £4.1 billion lower than forecast in the March 2010 Budget and it has carried this under-spend forward into future years which reduces public spending going forwards. and hence the forecast deficit

3.The OBR expects stronger underlying tax revenues over the next few years of an amount , sufficient to reduce forecast borrowing by up to 0.7% of GDP. So it is anticipating the continuation of a trend which was evident in recent figures which helped lead to a smaller budget deficit in 2009–10 than Mr Darling forecast in his March 2010 Budget.

4. The OBR’s forecasts are central estimates rather than supposedly ‘cautious’ ones. In other words in spite of the optimistic growth forecasts it would appear that civil servants used various ruses to influence the numbers (for example future assumptions about unemployment and hence benefit payments and taxes).

Conclusion

There has been I think a benefit from this process as I explained yesterday. My main concern is that with all the changes I have highlighted today and yesterday a rather similar set of numbers have appeared. One might wonder as they are so similar as to what the point was.

In addition please remember when you read such forecasts and constructs that there are only a guide and the guide is only as good as the assumptions used in it. The old computer phrase “garbage in garbage out” definitely applies. These are a framework for consideration and perhaps the best we can do now. On average they will be wrong rather than right.

It would appear that ex Chancellor Darling produced a more cautious set of figures than might reasonably have been suspected from his growth forecasts. This establishes two things I think. One is that the accusations levied at him by the new government look unfounded as his numbers have stood up to scrutiny overall. The second is that he may well have been a better Chancellor than he has been given credit for as it would appear that he resisted his neighbour more than was realised at the time.  I am aware that many will think that there is a certain irony in the manipulation of numbers and forecasts being used to thwart Gordon Brown.

Inflation in the UK

There has been a discussion on this site recently about money and wealth and some on types of inflation measure so today I shall review some previous discussion on this subject as I type awaiting todays inflation numbers. I still believe that the one taught in the economics text books I read at university ” a continuous increase in the general price level ” is the best measure of inflation although it is far from perfect. But it is reasonably measurable and does give a guide to the situation.

If we start from the beginning to measure inflation defined in this way you have to check the prices of a basket of goods over time and once you have done so you have a measure of inflation. So there is already there are 2 issues,firstly unless you check every price your measure will be imperfect and secondly if you change what you measure there will always be debate over what is included and excluded. In the modern era you can add hedonics to this where the authorities adjust the index to allow for quality improvements such as the way technology has improved although there is a lot of debate as to how this has worked in practice ( please see my comments section from last weekend for some views on this).

Also underlying the whole thing is the concept of a price. Again this seems simple. However just looking at my own supermarket basket I have been following a few items over the last year or so. For example own brand wine gums have varied between 27 pence and 85 pence. Recently a 300 gram tin of garden peas cost 14 pence whilst a 142 gram tin cost 26 pence. So what is the price of these two articles and what level of inflation would we get from them? It is not easy is it? Another example has been my favourite brand of tea (English Breakfast Tea), the price of this has varied considerably, one hundred tea bags were £3.92, then on an offer 50 of them were £1.50 and now 100 tea bags are £3.10. So what is the price? I like salmon but salmon fillets have gone from £8.50 per kilo to £11. I also like bags of mixed nuts where a 250 gram bag recently went from 85 pence to £1.20. As the world has changed as a nation we shop more at supermarkets. Everybody who does so will realise that they manipulate prices quite a lot. My contention is that it is hard to know the price of even something that you buy regularly and if you cannot determine the price you have no chance with calculating an inflation rate.

Hedonics illustrated

Another issue is that products change in terms of quality (usually for the better). For examples cars have tended to have higher specifications. To put this in concrete terms I remember paying 10 years ago an extra £750 for my car to have air conditioning. Now most cars have it as standard. Car prices have risen but the value of air conditioning is no longer £750 so what value should we use? It gets even harder in the case of something like an mp3 player that did not even exist to be in older cars! So how much of the increase in the price of a car is inflation? Those who try to measure inflation try to allow for this but it is not easy to do so.

Conclusion

When I started this blog one of my first articles back on the 17th November 2009 was on this subject and I still agree today with my conclusion (and am pleased to see I was rather prescient!).

So I hope that when you look at todays inflation numbers you take them with a pinch of salt and look at general trends rather than monthly figures. To my mind inflation in the UK as measured by the Consumer Price Index has proved to be quite persistent through a period when many were telling us it would be heavily negative and there are considerable implications for the future from this.

Today’s figures for inflation

These continue the disappointing trend of UK inflation figures. According to the Office for National Statistics Consumer Price Inflation is now 3.4% which whilst down on last month’s 3.7% is still higher than many thought we would get at any point this year and continues a trend of inflation being more than 1% over its target. On a month on month basis it rose by 0.2%. Ordinary RPI    is now 5.1% and has dipped back from last months 5.3%. RPI-X (our old targeted measure) is now 5.1% having dipped back from last months 5.4%. 

What has caused this?

This months slight slowdown in inflation has several factors behind it. The decline in CPI and RPI was driven by a fall in food prices on the month (particularly those of grapes and pork products)  as well as slower rises in the price of petrol, alcohol and tobacco than the same month last year. The RPI figures were also affected by a rise in their housing component as housing costs, which  have a higher weight in RPI than in CPI rose by 3.5 percent, their fastest pace since May 2008. This meant that the RPI figures as measured on an annual basis fell back by less than the CPI figures.

Conclusion

There are two ways of looking at these numbers. The first is to look at the fact that they have dipped back from last month which is welcome for the UK economy. However returning to my theme back from the 17th November last year one should also look at the general trend of the numbers and this has been poor throughout this year. Even todays lower numbers would have come as a shock to most observers if you have told them back in January as they are still 1.4% over the official target.

If you look at our previous target then the picture deteriorates further. The old targeted measure of RPI-X now at 5.1% had a  target of 2.5% so it is 2.6% over its targeted level. I am one of those who feels that the change in target was a retrograde step basically for the reason highlighted above, the new measure in general tends to give lower numbers and exceeds its target by less. That is not the way in my view to inspire confidence in your inflation statistics.

Going forwards over the summer I expect CPI inflation to drift back to 3% and I hope that it does so. However the question for the Monetary Policy Committee is based on 3.5%,3.0%,3.4%,3.7% and now 3.4%, these are the figures for CPI inflation so far this year and the question is from David Byrne of Talking Heads who in one of his songs opined “how did I get here?”

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16 thoughts on “Inflation figures for May 2010 are still somewhat disappointing

  1. I would like to ask a question, one I hoped the OBR would have answered. How much are we really in deficit by? That to include ALL off balance sheet stuff (PFI) as well as things like public sector pension liabilities. Surly we have to know the total liability BEFORE we can introduce a strategy designed to tackle the problem? Until we do it looks like more smoke and mirrors to me………

    • Hi Mac
      I think that the OBR did take us nearer to an answer. Personally I was relieved that the off balance sheet liabilities for the private finance initiative (PFI) were only (if you can use only for such a large amount…) £43 billion. To my mind that should be added to calculations of our national debt. In a world where numbers are fudged adding them may even help us as our credibility will be improved.

      As to public pension liability issues this is a difficult area. As I explained in a recent reply to a comment I have experience of final salary pensions and the cost of them and have the relevant Chartered Insurance Institute qualifications. What has happened is that the cost of such schemes has risen for several reasons. Mainly they are poor performance of equity markets over the last decade or so,falling annuity rates and the fact that on average we are living longer leading to the pension paying out for longer. These have meant that the estimated cost of a final salary scheme has risen from a 1/5th of salary to a 1/4 to perhaps a 1/3rd. I have seen a scheme which contributes 38% of salary as the highest extreme.

      So even the funded public sector schemes do not pay in enough and some pay in nothing at all. So there is clearly a shortfall but how much? It is not easy and I have a bit of sympathy for the OBR in this area and think it is sensible to take some time. My personal view is that markets will not always perform as poorly as recently but that some things like longeivity have changed. Therefore the old contribution of a 1/5th needs to be raised to as a minimum a 1/4th of salary. So I would capitalise the value of these schemes at 25% of salary as a starting point.

      However whilst this is based on experience it remains subjective as some matters such as investment returns are unknown. However it would be an improvement on now where we ignore the problem and hope succeeding genrations can afford to finance the promises our generation makes…

      • Thanks Shaun, but wasn’t there a little bit of fudge around even that £43B figure, that’s the way i read it anyway. As for the public sector pension question my authority are carrying a deficit of over £430M and expect the national government to sort it out for them! I was told ratepayers had no other option than to keep paying into it going forward. They hold about £4B worth of assets I would be willing to see that retained by the trustees and from now on used exclusively for pension provision, with no annual ratepayer injection, in the same way private pensions do. The old reason that public sector pensions are so generous because it makes up the financial shortfall employees have had to take in their working life has never held water in my view, even more so now! It is sobering to think about the fairly recent explosion in public sector employment and the effect that will have on these funds, the liabilities will be huge.

      • Very interesting, Shaun. Your comment about the poor performance of equity markets in the last decade, though not new, remains very disconcerting. Our private pension schemes were at one time predicated on a certain return from the stock market, I seem to remember 5% being quoted, though whether real or nominal was not clear. Now that seems clearly ambitious, though perhaps not in the context of the 90’s. Another factor is the rather large management fees that investment companies charge, often front-loaded as well as annual. They tend to gobble up a lot of the return.
        Can you please expand a little on the equity markets’ apparently poor performance and whether you think the next decade will be any better? Another, related, point is how much of public sector pensions is funded by employee and employer contributions and how much ‘pay as you go’ by the taxpayers.
        Finally, do you (like me) get confused when politicians quote public sector pension liabilities as a number, some kind of NPV (?), in £trillions? Over what period are they rolling them up? Why don’t they give the annual cost each year for the next decade?

        • Hi Carys
          If you look at the last decade in terms of the FTSE 100 index then it makes a curious picture. On a monthly basis we saw a high of around 6675 in August 2000 which was not seen until July 2007. If you look at it in terms of todays level well we were here so to speak in Spring 2003, July 2005 and late summer 2008 as well! So in effect we have declined through the decade as we stand now. There will have been a return from dividends but as you point out there are also costs. So from the equity componenet pension funds cannot have done well. Bonds have done much better over the decade so there will be returns from any bond component.

          Unless we see fundamental reform I see volatility remaining a function of equity returns. So the conventional theory of buying shares and holding them for 10/20/30 years in a fund is likely to be wrong. A better strategy in such an environment is to sell on rallies and buy on dips. So a fundamental change is required in investment strategies. My fear from the way governments around the world have operated is that they may have exchanged some benefit now for further problems down the road and hence even more volatility than what we saw in the 2000s. So if you “bob and weave” then the next decade could be a good one if you follow conventional wisdom I fear you will be disappointed again. As to bond markets well our own gilt market is now pricing it virtually another recession and accordingly is mispriced to anyone who believes we have a chance of avoiding that.

          Public sector pensions vary as to what is paid in. Some are theoretically funded some are not funded at all. I can’t think of any that remotely pay the true cost. If you were running a final salary scheme now then I think it would be sensible to invest between 25-30% of salary per year to pay for the pension. Whereas I think Nurses and Policeman/women pay 11 to 13%. Perhaps the worst example is the MPs pension scheme which actually gave MPs accelerated benefits. I did some calculations and wrote to my MP several times but I ended up being fobbed off and patronised by the Leader of the House at the time (Harriet Harman) who either did not understand the issues or did not want to (this was 5/8 years ago and predated the recent scandal).

          Actually I think everyone if they are honest struggle to get a grip on what a trillion is! I think politicians waffle and produce numbers they do not understand… There are a lot of problems with the way pension schemes are valued in my view so any numbers they produce are likely to be wrong anyway. I hope as time goes by to be able to raise a stonger voice in the debate.

  2. Butter has gone up from 85p to 96p in all my local supermarkets within a day of each other. 13% increase this week.
    When does “price comparison” become a cosy fix. When is a loss leader (if it was) a distortion of food inflation. There are many food items that are supposedly priced in no relation to costs so surely these should all be excluded from the inflation basket.

  3. Although it seems most publicly-acknowledged economists seem to believe that inflation will now continue to fall slowly this cannot be validly assumed and may prove to be an erroneous assumption. The track record of the MPC would lead any rational person to conclude that this is unlikely, since they do nothing. In any case what ultimately counts is the annual equivalence numbers, since these indicate the truth over the course of each year and decade in terms of aggregate debauchment.

    One economist who seems to consistently disagree with the wash of over-optimistic and unrealistic economists, such as MPC members, writes an interesting item today:
    http://www.cnbc.com/id/37700458, which is not with the mainstream.

    Then of course generally the effect of the coming emergency budget and the likely increases in some taxes does not seem to have been taken into account by most. This is one of the problems with re-defining what inflation is and attempting to measure it solely by its effect on retail prices. If taxes are increased this has the effect of seeming to increase retail prices, and even with all the tricks used to manipulate the supposed effects downwards, an increase in the inflation numbers is then likely. As Shaun indicates here today, this is one of the hazards in a very imperfect metric. Shaun’s quotation from David Byrne of Talking Heads “how did I get here?” ‘ then becomes apt, but on the basis of what must we now do to get away from where we have ended here, unintentionally?

  4. The popular year-on-year measure is only one way of presenting the inflation data, such as it is. If I look at the RP02 table, I find that the December 2009 level was 218. By the end of May 2010, it was 223.6. By my calculation, that means that, over the first five months of 2010, RPI inflation has been running at an annualised rate of 6.275%. Just another way of looking at the data.

  5. I would have thought it is a bit optimistic to expect the level of VAT receipts to stay constant as the OBR have forecast. Maybe Alastair Darling’s more cautious estimate will prove to be correct. If the price of butter and other staples jump so alarmingly and if people are losing their jobs it is more than likely that there will be less money to purchase more frivolous items for which VAT is levied. So it won’t only be VAT evasion to worry about as you state in point 1 above but rather a decrease in VAT receipts generally.

    All I know from my own experience is that prices keep going up. I can’t see us ever in a deflationary period in the UK as was talked about earlier in the year. On the contrary it would seem that there is a deliberate (but unspoken) policy to keep inflation higher than target which would have the effect of inflating away both government and personal debts.

    For those on fixed and/or small incomes and for those who are savers this is somewhat alarming and it would seem that the prudent are paying for the exuberance of others. Still we “are all in this together” so we mustn’t complain!

  6. I think you are correct, Janet. In addition the Institute of Economic Affairs’ (IEA) study has today warned that the actual UK debt is six times higher than official estimates (e.g. by the new OBR). The IEA study has claimed that the Treasury has racked up liabilities of £4.8 trillion – or 333% of Britain’s national income – because of the spiraling costs of state pensions. This supports my case that the OBR seems to be going the way of the MPC already. It also supports my earlier estimate that the real total public UK debts are around £4 Trillion.

    I came across what I feel is an interesting item today. That is a lecture given by Dr. Thomas Woods. I found this totally enthralling, and an accurate summation of the present general economic myopia. I recommend anyone interested to view it on
    http://vimeo.com/9857126. It lasts about 60 minutes, but after you watch the first 5 mins. I think you like me may be intent on watching the rest.It is delivered on a basis that even non-economists can understand. Some may conclude, at last an Economist who actually understands what makes things tick, and explains them as they really are and as they really interact?

  7. First time I’ve ever “dared” to post on a financial website, but here goes:

    I keep reading about “inflating away debt”, but for personal debt I don’t see how that would work…..For example (I’ll keep it overly simple):

    Say a person’s current nett pay is £1500 per month.

    Mortgage payments £800, food and utilities/essentials another £500. Leaving £200 disposable/savings.

    Inflation kicks in over a couple of years, so we now have:

    Mortgage £800 (no interest rate increase, unlikely I know but…), food and utilities now £600.

    BUT, below inflation increases in salary (that’s what seems to be happening), so nett pay now £1550. So only £150 disposable.

    Far from inflating away the debt, the person is worse off, even assuming a fixed rate mortgage or no increase in rates. Perhaps the figures aren’t too realistic but hopefully you’ll understand my point…..

    Please feel free to shoot this down in flames or explain that I understand it completely wrong.

    • I think your point is valid Mark,oh and welcome by the way.I think the idea of inflating the debt out (for an individual) acknowledges that,in the end, pay will have to increase as individuals are unable to meet their basic needs.

      That process however is in an industrials relations sense,painful.

      The main beneficiary of this process is the banks,the biggest losers are savers.

    • Hi Mark and welcome
      I am pleased that it is my site which has tempted you out of lurkerville! You are right to say that inflating away debt does not always work for individuals. For governments however it is a different story as their income does rise with inflation as its revenue for example will rise as more income tax and VAT is collected. It is simpler to think of it in terms of a debt level rather than monthly repayments. If you look at the UK we have a national debt of around £900 billion, in a years time if it was still the same then we would still owe £900 billion but inflation of either 3.4 or 5.1% depending on which index you use means that the governments revenues will have risen but the debt is the same.So in real terms the debt is less.

      Now for the individual in the past this would mostly also be true as wages have over time risen faster than prices in the UK. Going forwards over the next year or two there are questions about this I agree so for individuals it is possible that their debts will in effect be “deflated higher” in real terms. It is not an inspiring future and something that politicians try to hide but in real terms as individuals then the next year or two are likely to see a drop in wealth for this reason.

      If you look at places like Greece or Spain then the prospects are even worse for individuals..

      Andy’s point is very valid that savers as a group are also being punished . It has a corollary too. If savers and borrowers are losing who gains? Ah yes the banks who get yet another implicit subsidy

  8. Shaun,
    I have become addicted to your blog, a must daily read, I also greatly enjoyed the Tom Wood,s view of the free markets the link posted by one of your correspondents.
    Keep up the amazing blog
    Regards

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