The effect of rising food prices and will the Bank of England raise interest-rates as Governor King hinted?

After discussing yesterday the inflation situation in the UK that appears in drip drip fashion to be in danger of putting us in the sort of problem the Monetary Policy Committee by its inception was supposed to stop I spotted some new data on the recent topic of food price rises. This of course has contributed to the UK problem and to my mind has been the major cause of the recent riots across North Africa and Iran. The World Bank compiles a quarterly Food Price Watch which covers the period up until the end of January.

Global food prices continue to rise. The World Bank’s food price index increased by 15% between October 2010 and January 2011 and is only 3% below its 2008 peak. The last six months have seen sharp increases in the global prices of wheat, maize, sugar and edible oils, with a relatively smaller increase in rice prices……..The increase over the last quarter is driven largely by increases in the price of sugar (20%), fats and oils (22%), wheat (20%), and maize (12%).

Unfortunately there have been further increases in these basic products since the end of January and I suspect that some of the commodity price rises have not yet found their way fully through the price chain yet. Just to add to the problem the unrest in Egypt,Tunisia and now Algeria and Iran has led to this.

Demand drivers center around the possibility of large wheat importing countries, particularly in the Middle East and North Africa, coming to the market with large orders. These are related to assuring the public that adequate domestic food stocks exist during uncertain political times in some countries.

The World Bank has a rather chilling estimate of how many people may be seriously affected by the rise in food prices.

Estimates of those who fall into, and move out of, poverty as a result of price rises since June 2010 show there is a net increase in extreme poverty of about 44 million people in low- and middle-income countries.

I found the number of 44 million rather chilling and concerning. If you like it puts a human face (repeated 44 million times) on an economic issue. It also reminded me of the complacency of the Chairman of the US Federal Reserve (Central Bank) when he stated that countries have policies to deal with this problem which just by chance would suit his ends! And skated over the accusation that his policy of asset purchases has helped create this problem by at current levels buying 75 billion US dollars worth of assets each month putting the same amount of money in investors pockets. The money has to go somewhere and I suspect commodities has been one of the areas it has gone.

As to the precision of the numbers I counsel caution. The World Bank comes to 44 million by calculating 68 million city dwellers will go into poverty and 24 million rural dwellers/farmers will come out of it. This is much too accurate for such an estimate but the principle behind it holds I believe.

The European Union and the Euro problem

I have documented over the past year the problems of the Euro zone nations and in particular those of the peripheral countries such as Greece, Ireland and Portugal ( and Spain and Belgium). Rather improbably in spite of the current Burlesconi scandal Italy appears to have skirted this for now although her government bond yields are edging higher. However the story has been one of hyperbole and boasting by Euro zone officials about “shock and awe” rescue plans which turn out to be flawed. For example the EFSF or European Financial Stability Facility was so poorly constructed that a theoretical capacity of 440 billion Euros in practice tuned out to be around half that in practice. As the International Monetary Fund promised to increase such a fund by 50% the actual loss of firepower compared to the promises was around 300 billion Euros.

This week various Eurocrats have promised that the European Stability Mechanism or ESM (sorry about the names I don’t make them up….) will have a full complement of 500 billion Euros. I think they have been surprised the markets have not responded favourably. Perhaps they should examine their own track record of making promises! And indeed their record of actual competence. So markets are waiting for the detail of this. Also the ESM does not start until 2013 and many countries have problems which look like they need help now. What are they supposed to do?


At the top of the list of countries needing aid is Portugal and her Finance Minister Mr Teixeira dos Santos felt that the talks on expanding the EFSF were taking too long and that it should be able to buy the government debt ( Portugal….) of countries in trouble. Actually he had quite a few suggestions all of which involve the Euro zone and new ways it could help a struggling small country on the edge of the Iberian peninsula. So much for the abandonment of self-interest in the Euro zone and the European ideal.

Meanwhile the ten-year Portuguese government bond yield closed at a new Euro era high of 7.58%. Even her five-year bonds yield more than 7% now. This is important, as a measure of fiscal problems is the way that shorted dated bonds yields rise, as in ordinary circumstances they usually reflect the official short-term interest-rate. This is presently the European Central Banks (ECB)  1%, so there is a gap of around 6%. By comparison the German gap is 1.46% and the UK’s is 2.21%.

We will find out more today as Portugal has to issue some short-dated debt and we will see if it needs help from the ECB to do this. I would just like to correct some reports in the main stream media which say that the ECB has not bought any bonds for 3 weeks as last weeks numbers only include settled trades and the ECB was reported as a buyer on Thursday so the trades reported will not have settled by the latest figures.

The Governor of the Bank of England and the Chancellor

The UK monetary system requires that the Governor has to write to the Chancellor when inflation as measured by the Consumer Price Index exceeds its target by 1% or more. He is supposed to explain why it has happened and what he is going to do about it. The Governor is getting plenty of practice at this as on Monday he wrote the fifth letter of the current series! After the first one he writes quarterly rather than monthly.

These letters had become rather perfunctory but yesterdays was different, one section in particular and the emphasis is mine.

Inflation is likely to continue to pick up to somewhere between 4% and 5% over the next few months, appreciably higher than when I last wrote to you. That primarily reflects further pass through from recent increases in world commodity and energy prices. The Monetary Policy Committee’s-central judgement, under the assumption that Bank Rate increases in line with market expectations, remains that, as the temporary effects of the factors listed above wane, inflation will fall back so that it is about as likely to be above the target as below it two to three years ahead.

Just to spell it out “under the assumption that Bank Rate increases in line with market expectations” would mean three interest-rate increases of 0.25% over the next year with the first coming in May. I will discuss whether this will actually happen in a moment as there are other issues in this section of the letter.

Each time the Governor has to say that inflation will be higher than last time. It was maybe 4% last time and it is now 4 to 5%.

It is always as a result of “temporary” factors no matter how permanent they now look!

Inflation is always forecast to be on or around target in 2 years time although the Governor has slipped in a 2 to 3 years time hoping we wont notice.

In addition we got this.

Although one cannot be sure, prices excluding the effects of these factors would probably have increased at a rate well below the 2% inflation target

So if we take out the price rises then inflation would be under control………….Thanks Merv.

We did also get a sign of the dissent from the majority view on the Monetary Policy Committee.

Opposing these downside risks, there are also significant upside risks to the medium-term outlook for inflation. The period of above-target out turns for inflation could cause inflation expectations to move up and thereby affect wage and price setting. And import price inflation could remain elevated.

Will the Bank of England now raise interest-rates?

I still do not expect the majority to change much. Someone told me they expected a rise today when the Inflation Report is released! Whilst it is possible that Mervyn King and others on the MPC have had a “Road to Damascus” type conversion I suspect in reality assuming market interest-rates predictions is the only was he could get his figures and charts to work today when he presents his forecasts. Otherwise he would have to forecast inflation above target and in Mervyn King’s world that would never do! This is different from it being above target in practice which seems to bother him very little if at all…He really does seem to assume that the general population can be fooled all of the time to mis-quote Abraham Lincoln.


Perhaps the most damning thing I can say about current monetary policy is that in 1997 the hope was that appointing “expert” economists would stop the sort of mistakes that politicians continually made with UK inflation of acting too slowly. Yet now we see that the “experts” are making exactly the same error. To my mind it questions their very reason for existence as they are starting to look like another ineffective Quango. UK economic history is littered with the problems caused by letting inflationary expectations rise as this has proved difficult and expensive to reverse. Put another way we still have interest-rates for a financial collapse and a rapidly sinking economy when we are now in a recovery phase. 

Also the letter I quoted from above is supposed to say how the Monetary Policy Committee intends to reduce inflation. In essence we got the reply that it intends to do nothing.


11 thoughts on “The effect of rising food prices and will the Bank of England raise interest-rates as Governor King hinted?

  1. I would propose that HRH Merv. is guilty of “terminological inexactitudes” and, yes, he is fooling most of the people ALL the time. Clever! On a serious note, the figures for those in real food poverty do not make pleasant reading. If these figures are correct, one could say that (to bring the point home) 70% or so of UK is under this poverty line! Portugal has run out of options – IMF pdq, please. Even if their summer tourism season is a huge hit, it will do little to ease the pain the majority are suffering.

  2. “Also the letter I quoted from above is supposed to say how the Monetary Policy Committee intends to reduce inflation. In essence we got the reply that it intends to do nothing.”

    Hi Shaun, well, you don’t really expect any other approach, do you? I bet if he actually made some sort of definite statement about what he and the MPC proposed to do to reduce inflation you and a few other economists would probably have a serious heart attack instantaneously !

  3. Hi Shaun
    Thanks. The one theme I picked up from the February Inflation report webcast was Mr King’s continuing reference to how the low real effective exchange rate was helping to re-balance the economy – I gained the impression that real wage falls aggravated by inflation were some sort of trade-off.

    • Hi Shire
      This long after the depreciation/devaluation the Governor is still using words such as helping…….The reality is that so far we have had few gains from our depreciation and the one clear cut change has been higher inflation! Our trade figures show little sign of it although they are unreliable you would hope for a clue by now based on past history.

      As time goes by and inflation erodes any competitive price gains will we simply be left with a lower exchange rate and higher inflation? Only time will tell but it is a question which needs asking.

        • Thanks I will take a look.

          The musical reference reminds me of when I went to see Peter Gabriel as a teenager (who for those who do not follow such events was a founder member of Genesis who released this album) at Knebworth when he had just started his solo career. This was back in the days when such events had a younger age group present… He was good as I recall.

  4. I understand that, in theory, a weaker currency means that our export become relatively cheap and imports become relatively expensive: and that over time this feedback loop should result in a balance of trade. It is equally obvious that this is not happening – or not to the extent necessary to bring about an equilibrium. The questions, surely, are (a) why not? and given that explanation (b) where will we end up?

    Maybe some exported products are being price abroad in local currencies, meaning no increase in demand? Maybe some exporters are dependent on imported raw materials that are also increasing in price? Maybe, when we were already importing far more than we export, the increased price of these imports more than offsets any export gain – unless and until we reduce actual and nominal consumption?

    It must be possible for our theoreticians to model these effects!

    Equally I understand that, in theory, inflation should mean that the real value of our debt is reduced, making it easier to service (and ultimately to pay off). This is not happening either. The main reason here, appears to be that we are watching prices rise but not incomes. (Someone on a fixed pension, with a mortgage does not find the mortgage easier to pay because the price of food goes up – not my analogy, but a good one).

    But if we start to see income inflation, as Shaun observes, any benefit of devaluation in terms of exports will be lost.

    It would be very interesting if someone were to work out these second level effects – rather than just spouting the top level theory that a weak pound will stimulate export led growth and inflation will help us pay down the debt. It ain’t happening – and it probably won’t until something else gives. It would be nice to know what?

  5. “under the assumption that Bank Rate increases in line with market expectations”

    Just thinking out loud here. Is he asking permission to do this? Is he warning that he might have to?

    • Hi Dan
      In addition to my thoughts at the time (which were that he needed to assume rising interest-rates to get inflation on target on the Bank of Englands economic model at the correct time horizon of 2 years) I think one can suspect other motivations.

      Rather than a plan to actually raise interest-rates the Governor may be hoping that the £ will do some of the work for him if he hints he might do so. At 1.62 versus the US $ it is helping a bit. However the cautionary tale is that it is virtually always the holy grail of the UK economic policy to have a gentle rise against the US dollar and a gentle fall against the Euro! This hope is so old it used to be the Deutschemark and not the Euro. However we have rarely achieved it and trying to mainpulate the £ is fraught with hazards as it has periods where it moves too much.

      Of course UK economic history is more often concerned with falls than rises in the £……. However we had a lot of trouble when we rose against the Dm back when Mrs.Thatcher was PM. So we in the UK are usually unhappy with the value of £ wherever it is. Should the US $ have further falls any smile from the Governor will soon turn to a frown.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.