The situation in North Africa and Arabia is continuing to spread with crowd rallied not only in Egypt now but also in Algeria and the Iranian capital Tehran. Whilst these countries have autocratic regimes and their own issues my view is that the fundamental driver behind many of the protests is the rise in the price of basic foodstuffs that has happened since the latter part of 2010. An example of this is that in spite of the change of military leader there are now pay disputes on the streets of Cairo as real wages have been squeezed. Even though there has been a drop back from 500 the Commodity Research Bureau’s foodstuffs index at 491.73 is up some 23% on the 400 level it touched in late November.
Portugal’s Economy Shrinks
Another familiar issue is the problems of the peripheral nations in the Euro zone and a theme of this blog is that a deteriorating situation is usually accompanied by a Euro zone official doing an impersonation of the Iraqi general who used to go on TV claiming that the Americans were being crushed just as Abrams tanks entered Bagdad! To this end step forward, Jean-Claude Juncker Luxembourg’s Prime Minister.
The Portuguese authorities did take effective actions. If this action would reveal itself as not having been sufficient, other measures will have to be taken, but I have no indications that this has to be done in the short-term.
If he was looking for an indication all he had to do was look at her bond markets! One might also muse on “effective” measures which are not “sufficient”. Either way the yield on Portugal’s ten-year government bonds rose to 7.58% which is a new closing high for her time as a Euro member. This time the European Central Bank did not ride to the rescue and was not seen as a buyer. Also this was seen on the ECB website.
As no SMP transactions were settled last week, it happens that the rounded settled amount – and the intended amount for absorption accordingly – remains unchanged at EUR 76.5 billion
Care is needed here as they were reported as buyers on Thursday and these numbers only include settled trades up until Friday so I expect them next week.
The problem for Portugal was the announcement that her economy as measured by her Gross Domestic Product fell by 0.3% in the last quarter of 2010 according to her National Statistics Institute. Added to this because of the government’s tightening austerity programme The Bank of Portugal forecasts a fall in GDP of 1.3 per cent this year. If we look back we see that the previous 2 quarters both had growth of 0.2%. So the pattern for Portugal now looks like a very strong start to 2010 where growth in the first quarter was 1.1% followed by a sharp slowdown and now a dip which is worrying. Portugal’s politician’s tried to emphasise that growth on a year on year basis was 1.4% in 2010 but this only reminded everyone that nearly all the growth had taken place in the first quarter.
Projecting forwards from the latest numbers also has a concern as the fall at the end of 2010 was driven by a reduction in consumer spending and at the beginning of 2011 the government reduced public-sector pay by 5% and also increased the level of VAT which taxes consumption. So there is a clear danger of Portugal re-entering recession and staying there in 2011. Falling economic output is one of the worst influences on a solvency problem particularly in a country which has had low economic growth rates since the 1990s. Accordingly bond markets are right to be concerned and Herr. Juncker needs to brush up his economics.
The UK Inflation Problem worsens
This morning the Office for National Statistics has released the following figures.
CPI annual inflation – the Government’s target measure – was 4.0 per cent in January, up from 3.7 per cent in December
RPI annual inflation was 5.1 per cent, up from 4.8 per cent in December.RPIX inflation – the all items RPI excluding mortgage interest payments – was 5.1 per cent in January, up from 4.7 per cent in December.
Why did inflation rise again this month?
The ONS told us that the rise in VAT to 20% was an influence as was the increase in the price of crude oil. The particular areas that saw price rises were fuels and lubricants(VAT and Crude Oil), restaurants and cafes (VAT),alcoholic beverages (These rose by 6.7% so the ONS’ s attempt to blame VAT does not wash here),furniture and furnishings, and car prices. We should be grateful for some sectors where there were price falls as otherwise the numbers would have been even worse. These were recreation and culture,miscellaneous, and clothing and footwear.
The same influences were seen on both the Retail Price Inflation numbers
Yet Another Statistical Manipulation
This happened to the clothing and footwear section.
The main downward pressure was due, though, to the weight for clothing and footwear being higher in 2011 compared to 2010. This means that the fall in prices between December and January this year had a larger downward effect on the CPI compared to a year ago.
Perhaps nice for the figures for now but if cotton prices remain where they are this will misfire fairly soon! For those who have not be following their rise cotton prices have doubled since mid-2010.
Remember the Producer Price Inflation figures
Last Friday I reported the following Producer price figures where output inflation was recorded at 4.8% and input price inflation was recorded at 13.4%. As you can see there is no drop back in inflation likely from the output figures and the input price figures suggest a further acceleration. They are perhaps the biggest criticism of the Bank of England’s stated view that inflation is “temporary” and the result of “one-off” factors.This is because they indicate that inflation is if anything building up in the chain that eventually leads to prices on the high street.
In fact these figures are likely in reality to be even worse as I reported on Friday they have been subject to a statistical manipulation by the ONS which in 2010 led to a reduction in the figures for output price inflation for every month recorded! Allowing for this I feel that the levels under the previous system would be 5.4% and 14.2%.
What does our inflation watchdog the Monetary Policy Committee think?
Let us go back to the quarterly inflation report from February 2010 and examine what it forecast for now. The emphasis is mine.
CPI inflation is likely to remain elevated in the near term, given the restoration of the standard rate of VAT to 17.5% and the continuing adjustment to the past depreciation of sterling, before persistent spare capacity causes it to fall back to below the target. ….. it is more likely than not that inflation will be below the target for much of the forecast period,
If we look at the accompanying fan chart we can see that the Bank of England expected CPI inflation to be approximately 1% at this time before drifting up to 2% in 2013. This type of forecasting has been a feature of it for some time. Firstly it was/is hopelessly wrong and secondly it always predicts inflation to be on target around the target horizon. We get their latest update tomorrow and with their record which is now shocking because it has been wrong time after time it will be hard to know whether it is right to laugh or cry. More importantly and this is the crucial point it means that they have set UK monetary policy with the wrong expectations for UK inflation leading to what I believe are policy errors. I notice some in the media concerning themselves as to whether this is deliberate or not but if you think about it this no longer matters. As this has repeated again and again then whether it is deliberate or grossly incompetent seems to me to be much less important.
As you can see the Bank of England has more than just a headache caused by rising inflation. It has consistently made the error of expecting inflation to be lower than it has turned out to be. Why this matters is that these forecast are used as a basis for the setting of interest-rates. Looked at like this I feel it is unarguable that monetary policy has been inappropriate and a policy error has been made.
As 2010 has progressed and moved into 2011 we have seen that the UK does have a persistent inflation problem. This is not on the scale of some of the problems we have had in the past but when you consider that we have just had a severe recession and you allow for that it is troubling. This is because should the economy begin to pick up and grow on a more sustained basis it is likely that inflation will pick up too and it will be doing so from a relatively high base. There are plainly issues in the background of rising commodity price inflation and we are letting it seep into our system forgetting all the dangers that have come from this in our past.
Apologists for the Bank of England argue that there is nothing it can do about inflation which is “imported”. This is an odd argument which is not far short of economic illiteracy. For raising interest-rates is usually associated with a rising exchange rate which does help with imported inflation,particularly if the rise is against the US dollar. Indeed it used to be one of the arguments of the Bank of England! I doubt they have forgotten. Please do not misunderstand me you can of course argue that you think that this would be the wrong policy my point is against those who are arguing it is not a policy option.
My Policy Prescription
As we look forward there is a continuing and indeed rising danger of inflation becoming embedded in the UK economic system. As our inflation watchdog is either asleep or not doing its job I would like to repeat the policy suggestion that I first made back in the autumn of 2010.
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives and their record is going from bad to worse.