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.
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%.
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?