Inflationary forces are gathering in the UK,Europe and even in the United States with input inflation rising strongly

I have been reporting since last summer about the rise in commodity and crude oil prices and their potential impact on world inflation. Some countries are already suffering from the effects of this with Chinese consumer inflation for example having risen to 5.1% and retail price inflation in the UK is at 4.7%. I reported back on the 5th of January that overall Euro zone inflation had risen above target to 2.2% with Greece the outlier with her consumer price inflation now running at 5.2% although in her case the rise is partly attributable to a rise in consumer taxes such as Value Added Tax.So the impact of the commodity price rises has begun to feed into measures of inflation.

What is currently causing this?

I wrote yesterday about the recent rises in commodity prices as measured by the Commodity Research Bureau spot index which rose again on the day by 1.39 to 537.91. The main contributors to the rise were the livestock and foodstuff components both of which rose by more than 1%. Indeed with their being riots in one or two parts of the world at this time over food prices I took a closer look at the foodstuffs component of the index. The rally started on November 29th of last year when the index closed at 400 whereas last night it closed at 468.66 for a rise of 17% in just over a month.Heady stuff indeed. There were problems with food prices back in 2008 but the foodstuffs index used hit only hit a peak of 449 back then which we now have comfortably passed.

The foodstuffs index has the following constituents: Butter,Cocoa,Corn,Hogs,Lard,Soybean Oil,Steers,Sugar and two measures of wheat prices.

The President of the European Central Bank Mr.Trichet responds in its monthly press conference

The rise in inflation in the Euro zone to 2.2% caught out the President of the ECB. I wrote this on the 5th of January on the subject referring back to his statement at the ECB’s December meeting.

Well, there are German citizens in this room. They can say that the euro has given the 330 million citizens of the euro area, including their compatriots, price stability, with inflation standing at 1.97%. Nobody ever challenges this when I say it. In Germany, the figure is even better. For Germany, inflation has stood at around 1.5% since the inception of the euro, the best result for Germany and indeed the euro area as a whole in 50 years. Frankly, for an institution that was called on by the citizens of Europe to have a primary mandate of delivering price stability, I think this is worth repeating.

As you can see in an unfortunate accident of timing Mr.Trichet crowed about a good inflation performance just as it showed signs of going wrong! I had wondered how embarrassed he would be and we found out yesterday when at the January ECB press conference he said this and the emphasis is mine.

Taking into account all the new information and analyses which have become available since our meeting on 2 December 2010, we see evidence of short-term upward pressure on overall inflation, mainly owing to energy prices, but this has not so far affected our assessment that price developments will remain in line with price stability over the policy-relevant horizon. At the same time, very close monitoring is warranted. ……… Our monetary analysis indicates that inflationary pressures over the medium term should remain contained.

The impact of this clattered into financial markets virtually immediately but Mr.Trichet was not quite finished on the subject.

Looking ahead to the next few months, inflation rates could temporarily increase further. They are likely to stay slightly above 2%, largely owing to commodity price developments, before moderating again towards the end of the year. Overall, we see evidence of short-term upward pressure on overall inflation, stemming largely from global commodity prices. ……..Risks to the medium-term outlook for price developments are still broadly balanced but could move to the upside. Upside risks relate, in particular, to developments in energy and non-energy commodity prices. Furthermore, increases in indirect taxes and administered prices may be greater than currently expected, owing to the need for fiscal consolidation in the coming years, and price pressures in the production chain could rise further. 

Comment

This was quite a move from Mr.Trichet as he in a month has gone from crowing and complacency to concern about inflation. Indeed in my view there is something of a repositioning of the role of the European Central Bank going on here. Mr.Trichet is reminding everyone that its central role is price stability and hinting that in spite of the Euro zone’s current difficulties he would be willing to raise interest-rates in response to this if necessary.

Markets responded to this like a greyhound out of the traps. The Euro shot up from just over 1.31 against the US dollar to over 1.33 very quickly and is now at 1.34. There is an interest rate future based on Euribor and if we take the contract for December 2011 it fell by 0.1 to 98.39. These type of futures contracts are confusing to the uninitiated as you have to subtract the price from 100 but the interest rate implied rose by 0.1% on the day. Indeed it had been rising recently and has now risen by0.24% since the end of the year.Put another way over this period it has factored in an interest-rate rise.

US Wholesale (Producer) prices rise too

The US Department of Labor produced these figures yesterday. The output or finished goods measure rose by 1.1% in the month of December which follows on from increases of 0.8% in November and the 0.4% of October. The annual rise is now 4%.  However if we look at what is called the crude goods or input measure we see signs again of commodity inflation as this rose by 4 % in December from the previous month, and rose 15.5 % in total for 2010.

So here we end up with inflationary influences with input prices up 15.5% in 2010 but also a potential deflationary influence as US companies have only been able to raise their prices by 4% leading to quite a squeeze on margins. How this situation resolves itself will be one of the main drivers of what happens in 2011.

The Problems with UK Producer Prices persist

This morning has seen the Office for National Statistics release new numbers for UK producer prices and they are as follows.

Output price ‘factory gate’ annual inflation for all manufactured products rose 4.2 per cent in December.Input price annual inflation rose 12.5 per cent in December compared to a rise of 9.2 per cent in November.

For some reason they fail to point out at this point that output price inflation had risen from 4.1% in November which itself had been revised up from 3.9%. In fact the November input figure had been revised up too from 9 to 9.2%. If we look at the reasons behind the surge in the input price measure then we see two rather familiar trends as food and energy top the list.

A Convenient Change in the calculations

I wrote on the 19th of November and the 14th of December about a change in the way that the ONS calculates these figures. My conclusion is illustrated below.

This seems innocent enough but I have looked at the numbers for 2010 and this is its impact on the headline output number for produced price inflation for the months of this year so far. They are -0.3%,-0.4%,-0.5%,-1%,-0.5%,-0.7%,-0.8%,-0.5% and -0.6%.

As you can clearly see there is something of a trend there! Official recalculations of inflation figures leading to a fall in reported inflation lead to a reduction in the credibility of the figures. Looking at the previous trends for this my calculations lead me to believe that on the old basis we would be reporting output price inflation of 4.8% this month and input price inflation of 13.3%.

Comment

UK producer prices have indicated that there is an inflation problem in the UK for quite some time now. In spite of the efforts of the Office for National Statistics to recalculate and “represent” the figures we still have a problem. Even under the new system the numbers for input price inflation have accelerated again and it leaves us in a similar position to that reported in the United States above where manufacturers are seeing high rates of increases in their input prices but so far they are struggling to fully pass them on.

These figures are yet another criticism of our Monetary Policy Committee which yesterday again left interest-rates unchanged. Its argument has been that the rise in inflation is temporary and yet the input price figures released today pose a direct challenge to such a conclusion. If their rise was one-off or temporary there should be some evidence of a plateau or even a fall instead we see an acceleration and indeed the highest annual rate since April of last year. One can only suspect that this rise will feed into the output price measure as 2011 progresses and accordingly into our measures of consumer and retail price inflation.

In my opinion we face a difficult 2011 in many respects as there are various contrary influences. For example the producer price figures released today show that at the beginning of the price chain prices are accelerating but also that margins look like they are being squeezed. So a clear inflationary trend with a hint of a deflationary influence! Nobody said economics had to be simple…… However I feel that our official policy has been left behind and we would be in better shape to respond if we have higher official short-term interest-rates and this has been my argument since December 2009. I get asked about this so let me make it clear I feel that we need to be like a boxer on his toes ready for developments and that an interest-rate in the range of 1.5 to 2% would help with this. I know that many are concerned indeed some seem to be terrified of any increase in interest-rates but let me put it like this,such an interest-rate would still overall be expansionary merely less expansionary than before and would have the side-effect of helping to rebalance our economy.

To my mind continue the present policy of 0.5% official interest-rates has another flaw. By definition it was an emergency interest-rate, if 22 months later we still feel we are in an emergency then question number one should surely be how much of an impact did it actually have? Whilst we are at it there is £200 billion of Quantitative Easing as well in the equation.

From time to time I like to pose a question for readers and here is today’s. Do you think that the UK is still in an emergency?

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12 thoughts on “Inflationary forces are gathering in the UK,Europe and even in the United States with input inflation rising strongly

  1. Yes we still have an emergency, but only because we not extinguished the fire – our reckless banks.Our banking system cannot cope with any further declines in asset prices. Which is why rates are still at emergency levels and we have printed money.We are trying to hold up asset prices ,in particular real estate.Only the banks benefit from low overnight rates,retail loan products are no cheaper.

    Of course we should have been using the past 2-3 years to plan how to cope with the eventual fall-out. Splitting the banks, developing a state controlled money transmission system for the population,real funded protections for savers etc.But we didn’t.

    So instead we have opted for inflation. As we have a longer duration gilt portfolio (13 years or so) compared to many nations we fare better than most nations.However we cannot reduce of dependence on deficit funding in time for yields to make us insolvent.

    The big losers in this are retail borrowers,whose earnings will not keep track with inflation and of course savers.The withdrawl of sale of NS&I linker certificates was no unfortunate co-incidence.

  2. I think we are still in an emergency. But the current emergency is not the same one as we started with. We now have a new one, partly caused by the very policies that were used to fix the last one.

    Consider:- about 46% of the population will get a pay rise this year. So by default 54% won’t. Of those getting a rise, many will be on or close to the minimum wage, and their inflation level is much higher thereby negating the small increase they get this year. So the true percentage getting an increase this year is likely to be effectively sub 30%.

    If costs are rising at 5% or more (pensioner inflaton has been spouted at 10-11%), and the vast majority of the population isn’t getting an increase, then their disposable income will shrink. They must therefore buy less and their financial position deteriorates further (another problem for the banks?).

    At some stage surely this will result in a reduced tax take? Which will worsen the Govt’s position and the whole economy leading to actual cuts required rather than real terms cuts (govt spend actually increases over this parliament!).

    So the current emergency is surely one of passing the pain from a relatively small number of people who overextended to buy a house/flat to the population at large. The consequences of which could very well be more severe than just letting the original problem play out and picking up the pieces?

    Or am I missing something?

  3. I would say that the UK’s position is stable currently but is still delicate due to it’s exposure to shaky foreign investments and/or debts (Ireland in particular). Should the new Irish Gov’t pull an Iceland and refuse to backstop their banks the UK would be in some trouble.

  4. Not being an economist, I’ve been thinking at why people are asking for the UK base rate to be increased. I have don’t have an opinion either way at the moment, just sitting on the fence!

    If I understand those asking for a rate rise, correctly, they want a rate rise to hopefully curtail some of the UK’s inflation rises. However, inflation appears to be increasing due to commodities increasing in value, not because the average UK worker is asking for a wage rise. However, I do understand, and am certainly feeling the pinch, why workers would ask for a wage rise, just so they can keep pace with prices. This in turn would force companies to put up their prices to pay for the new wage demands, and the spiral continues.

    However, if we look at who’s the main driver behind commodity prices going higher, it’s mainly China, with her rapacious appetite. So what to do? We increase UK rates and have a spiral effect, or do we wait for the Chinese economy to implode, as many have been saying for, I would say, 18 months, and then commodity prices will plunge. I don’t confess to have an answer, but although I feel the MPC have been behind the curve for a long time, and I wholly concur with Shaun’s apposite comments about certain members of the Committee, I can possible see their quandary.

    Robert

    • Robert,

      Inflation is bad for savers especially those who buy debt, if inflation goes higher then so do interest rates and thus the lower output produced. At the moment the printed cash (QE) is keeping rates lower than they would be but if savers believe the BoE has abandoned the inflation target then they will demand more return to cover for the higher inflation thus higher borrowing costs.

      During the boom from 2000 to 2007 the UK imported massive deflation and therefore the Bank of England held rates too low to create domestic inflation to bring the overall level to 2%.

      Its all about setting expectations and maintinaing credibility. If you lose credibility then you lose control of events and the markets will set policy for you.

    • Part of this problem is that people in the UK borrowed too much. When the base rate is too low it encourages more borrowing and discourages saving. My business loan from 2005 costs 3.25%, RPI is 4.7% – I think my bank is losing 1.45% per year in real terms (Eg – adjusted for inflation)

      Why would anyone want to save money at 0.5% interest, or a -4.2% real return using the RPI inflation rate ?

      Also – look at bank loans now – the banks regard the 0.5% base rate as fictious when issuing loans. This means that you may be asked to pay 10% or 12%

  5. No. I think Greece & Ireland are receiving emergency CPR by the paramedics but the UK is “comfortable” in intensive care. Still every possibility of a relapse though, as this horribly contagious “defecitis” is a pernicious disease. Once it takes hold, recovery is a slow and difficult process and there is a severe risk of it developing into full-blown bankruptsia.

    The UK could do with some private medical care though, as the state provided doctor doesn’t seem to be treating the condition properly.

    It looks to me as if a pandemic could be on the horizon. Trouble is, the incubation period for defecitis is years, sometimes decades. 😦

  6. “From time to time I like to pose a question for readers and here is today’s. Do you think that the UK is still in an emergency?”

    My answer to that question is much like the first two here. I think the UK is still in a position of economic emergency, but not the one which gave rise to the present “emergency” artificially low base rate and QE. I believe that the emergency now is that the naive attempt to avoid the natural economic correction necessary has not worked; indeed it has as many expected actually made the situation worse, and it is continuing to deteriorate.

    The emergency which we face now, I believe, if the present policies are continued, is hyperinflation. There will then no doubt be an attempt to take some corrective action, but it will be too late by then, and eventually Sterling could collapse. Once inflation gets into a runaway condition it becomes increasingly impossible to stop; at that point increasing interest rates nor other measures have much if any effect. We need to look again at the lessons in economic history, which most in positions of authority today have evidently overlooked or are just deliberately ignoring.

    It is all very well of course to be critical, but it is not rational to be so without advocating what alternative action should be taken which could solve the emergency. I believe that the essence of the problem which we now face in the UK is that public spending has grossly exceeded the proportionality of real wealth generation and as a direct result has throttled real wealth generation. Thus naturally the economy is demanding a correction to return to equilibrium. This is the nature of all Cybernetic systems.

    The only way to smoothly correct the balance is not one which most want or are prepared to face; that is that present government spending (including off-balance sheet spending) must be cut by 50% to revive the economy. In addition there needs to be a clear-out of the Left-Wing deadwood at the BoE, and its management needs to be replaced by Bundesbank-style, competent, politically-neutral economists, and the MPC abolished. The BoE should then be given full independent responsibilities to control the monetary system, ensuring no further inflation – not even 2 or 3% per annum. If a fiat currency system is to continue there should be a formulation devised whereby the money supply is controlled directly related to the real wealth inherent in the economy, so that it can be increased or decreased accordingly as real wealth rises or falls.

    Politicians thereafter would have to overtly collect the taxes which they need to finance their spending, and if they act in a profligate manner the electorate would throw them out of office because of their excessive taxation.

    Once these changes were introduced the UK economy would start to grow again naturally and prosper. That of course is only the essence of the necessary solution and there would need to be other components to ensure overall coherence. Of course it will never happen, and we shall continue along the track of the present disaster!

  7. As soon as the Central banks decided QE was the solution it was only a matter of time before inflation reared up. Unfortunately as it does every time there is no trade off between inflation and growth so we will end up with stagflation. The only benefit being that wages will pick up and the general price levels will bring down the real value of debt.

    The sting in the tail will be the higher future interest rates but the baby boomers dont really care.

  8. ‘’Do you think that the UK is still in an emergency?”

    I think it’s quite clear we are, even after the present round of housekeeping we are still going to have to borrow more for day to day expenses. Having to almost use a spectral microscope to measure our way out of official recession any hope of growth to build our way back to normality seems a forlorn hope. ‘We’ couldn’t manage the boom ‘we’ have no chance of managing the bust!
    It seems everything done with regard to political economic policy these days is more akin with the King Canute tale. As has been mentioned we need economic free thinkers to provide the models needed to tackle contemporary problems, not ones blinkered by historical models. It’s either that or we have to allow the full ramifications of the bust to roll out. We are bankrupting ourselves protecting people and asset bubbles who and which have no real sustainability.
    We had, and still have, the chance to transform our country, economically and societally into something fit for the 21st century, something we can be proud of to bequeath our children, instead we have bankrupted them to pay for our prolificacy! I agree with Andy a good starting place would be the banking sector making that fit for purpose. I also think, seeing as food inflation has been mentioned, we should be sorting out indigenous agricultural, now before it’s too late!

  9. You could characterise the current state of play as an emergency, because the problems are still emerging: and not yet as a crisis because we have not reached the turning point.

    To my eye, it is slightly different: in that everyone has placed their bets and we are now waiting for the wheel to stop spinning. No-one really knows where the ball will end up but most of the money is backing the idea that if we hold up asset prices for long enough, confidence and growth will return and enable us to pay off the accumulating debt. (Particularly if you add a bit of inflation and austerity into the mix).

    I’m not really convinced by this. It may be so, and if so all well and good. If not, the next “emergency” will be an accumulation of evidence that the current approach is not sustainable. Maybe, Government spending does not fall by as much as forecast (and it’s not even forecast to fall in nominal terms); maybe tax revenues do not increase by as much as forecast; maybe inflation accelerates to a point where interest rates have to rise.

    If (once) people have to start rethinking their current strategy things could get messy.

  10. What i’m hearing is everyones denial. Raising interest rates 3 and a bit years ago unstabilized the economy, yes there is still a crisis and imho it is going 2 get worse. Why are commodities rising 2 me is debt and demand from booming countries like China who are raising interest rates and will cool demand then along will come deflation which wil cause many businesses 2 go 2 the wall & homeowners 2 lose their homes. The government imho are preparing us so we can ride the storm. May i take u back 2 the early 80’s prices were high but as unemployment rose bankrupsies soared cheap gd’s abound & new players entered the market. I believe it will be like that but worse. There is no easy way out but this time we unite like the blitz. Oh banks will fail but u’ll get ur money and the government will seaze the assets. I’ve studied the great depression as a layman & it makes sense 2 me.

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