The inflation tectonic plates are showing signs of a shift

The last 18 months or so has seen a proliferation of countries reporting first falling rates of inflation and then negative annual rates. The commentariat got themselves into something of a mess on this front invoking “its the end of the world as we know it” before having to U-Turn like they are Mark Carney. We knew better here but I note that for the argument I have satirised as being for the “deflation nutters” there has been some interesting developments this week. This morning produced one from the British Retail Consortium.

Another fall in shop prices was seen in February, down 2.0 per cent compared with a year ago and a further fall on the numbers we saw in January as competition in the industry continues apace. This now marks the 34th consecutive month of price drops and 35th for non-food prices.

So the beat goes on and it was joined by a small drop in food prices. Actually for once the word deflation may be appropriate if we look at their longer-term view of the retail climate.

These effects could mean there are as many as 900,000 fewer jobs in retail by 2025 but those that remain will be more productive and higher earning.

However some care is needed here as a fair bit of this is the shift to the online/digital world and wages will be pushed higher by the National Living Wage. If we return to prices then petrol and diesel prices are at their cheapest for 6 years according to official data. here let me particularly welcome the end of a feature of rip-off Britain where diesel car drivers pay more for fuel as both fuels now cost £1.014 per litre.

The Euro area

We were told this only on Monday.

Euro area annual inflation is expected to be -0.2% in February 2016, down from 0.3% in January, according to a flash estimate from Eurostat, the statistical office of the European Union.

Again we saw a barrage of knee-jerk responses to this which for its own reasons – to justify its planned easing next week – the European Central Bank (ECB) has joined in with this morning. From @livesquawk

Villeroy: Sees Negative Inflation For ‘Several Months’

As you can see this feeds right into the “deflation nutter” zone although of course we are dealing with past trends as the data and the forecast are on the back of what has happened whereas we want to know what happens next and I am increasingly thinking that Florence may be right.

It’s always darkest before the dawn

It is always nice to support someone else who grew up in Camberwell and here lyrics also provide something of a critique for central bankers.

And I’ve been a fool and I’ve been blind
I can never leave the past behind
I can see no way, I can see no way
I’m always dragging that horse around

The oil price

There are various levels here and the superficial level is simply note that even at US $37 or so per barrel it is down 38% on a year ago. Now I do not know whether the forecasts of a fall to US $16 per barrel will happen but they do sound a bit like the ones projecting a rise to US $200 when the price was above US $100. Or “The only way is up” has been replaced by “down down” on the airwaves.

But whatever happens we are now unlikely to see a continuation of this reported by Eurostat in its consumer prices release.

energy (annual rate) -8.0%, compared with -5.4% in January.

We may see monthly flickers of this because this time last year the oil price saw a bounce which saw it rise to nearly US $70 on the Brent Crude benchmark in early May 2015 but as we move through summer we will be comparing to lower levels. Once the oil price impact begins to fade we will be concentrating on other aspects of inflation.

services is expected to have the highest annual rate in February (1.0%, compared with 1.2% in January),

This would hardly be a surge but it would change the emphasis as we see Euro area inflation rise towards its target.

If we move to the United States then they have an inflation linked bond market called TIPS. The St.Louis Federal Reserve has done some calculations about what oil prices would have to do to justify the current pricing structure. Thank you to Macro Man for the heads up and the emphasis is mine.

According to our calculations, oil prices would need to fall to $0 per barrel by mid-2019 in order to validate current inflation expectations. After that, there is no oil price that would allow our model to predict a CPI path consistent with December 2015 breakeven inflation expectations. This implied path of oil prices is very different from the path of oil prices implied by futures contracts, which rises to more than $50 per barrel by mid-2019.

There are issues with their assumptions but I think you get the gist of their argument in that quote.

Oil and commodity prices

These have been rising recently. Since the 20th of January the price of a barrel of Brent Crude has risen by US $10 per barrel.  As you can see from the chart below then Dr.Copper has for now stopped falling.

The UK

There are other issues here of which one relates to tax. As there are problems with the public finances the temptation to apply something like the old fuel price escalator may prove irresistible. It can ever be presented as helping the Bank of England with its mandate! Although of course it would be punishment for the UK worker and consumer via a reduction in real wages. Whilst a tendency to institutionalised inflation has a British theme a need for tax revenue appears elsewhere so it may not be alone in having such taxing thoughts.

There is also the issue of the UK Pound £ which has been falling in 2016 against the US Dollar which is the currency the majority of commodities are priced in. It is down just over 9% on a year ago with the fall beginning in the late summer of 2015 and picking up speed in 2016.

Also UK services inflation has been more persistent than in the Euro area and currently it matters little which measure you use. Sadly the new ONS website is telling us that the new data will be released on the 16th of February so it is good news that I recall the numbers being 2.3% (CPI) and 2.4% (RPI). So as the oil price effect wears off we will see the UK return to a more normal inflation position.

Also the UK methodology looks in need of a rethink to me. After all services are an ever bigger part of the economy as we have “rebalanced” towards them and I wonder if thus has been fully picked up. The inflation numbers should be better than the 2012 78.6% of GDP that is used for economic growth but may still be inaccurate.

RPI versus CPI

On this subject which many will tell you is a simple issue let me add something from the Royal Statistical Society website where Gareth Jones has posted this.

From 2011 to 2014,  the figures based on CPI indices are quite different to those based on RPI indices.  The CPI based volume shares continue to rise, while the RPI based figures fall.

Given that this period was one of falling real incomes, One would expect a fall in volume share for clothing, as it is to a large extent a form of deferrable capital expenditure.  On this basis, the RPI based figures are more plausible than the CPI based ones.  This adds support to the RPI price indices rather than the CPI price indices.

There are caveats but my argument has been that the debate is one where there are issues on both sides and not just the lazy RPI is bad produced by organisations such as the Financial Times. It was a change to clothing which produced a lot of the debate on UK inflation measurement and the establishment push for a lower number. The more of a case for RPI of whatever variant the more we move away from negative inflation.

Comment

The disinflation picture is one which has carried on for longer than expected. The ECB in particular embarrassed itself by missing the trend and then ended up in hot pursuit without catching up a bit like the Sheriff in the Smokey and the Bandit films. However from now they need to look a year or two ahead and after a few months of continued oil price disinflationary pressure we see an increasing chance of inflation rising. As I pointed out back on the 3rd of December then central banks should be beginning to adjust policy in response. Except as we have seen from the ECB and Bank of Japan and expect from the ECB next week they have already eased again and more is expected. The Bank of England could easily join in.

Meanwhile if we added asset prices such as housing to consumer inflation measures we would see a different picture again. There is a Eurostat measure for this where the UK owner occupied housing sector would be registering inflation of 1.9%. It is dreadfully flawed but much better than nothing!

Meanwhile if you prefer to listen rather than read here are some of my thoughts in that format from Share Radio earlier.

trends in the UK – Shaun Richards after another month of shop price

 

As a last point once you start to think that inflation will stop falling and then rise well where does that leave both low and especially negative bond yields?

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9 thoughts on “The inflation tectonic plates are showing signs of a shift

  1. Hi Shaun

    As you say, you would have thought that, in the context of a policy horizon of two years, the imminent disappearance of the oil price fall effect and the fall in the pound would cause the BOE to be considering the probability that inflation will rise, possibly quite significantly, and that therefore interest rate rises should be on the radar.

    That they are not says a lot. The BOE will only put up rates when it has no other choice – probably to defend sterling against a precipitate fall; its main option is soft default of the debt burden through the inflation rate. We have to have low rates because we have too much debt. The excuses for not acting will of course be Brexit or its aftermath; the general World slowdown; China, in fact almost anything apart from what the Governor’s Tarot cards say.

    They are stuck.

    • Hi BobJ

      You are right to point out that there is a clear problem with the strategy of the Bank of England. I believe that their view was that promising to increase interest-rates would do most of what actually raising would do. Forward Guidance instead got some poor mortgagors to make a mistake.

      Meanwhile with the recent UK economic news including the PMIs for manufacturing and construction we may be nearing the time that someone votes for a Bank Rate cut. This in inflation terms will be like when Mervyn King voted for more QE just as the UK economy began to boom.

  2. Shaun,

    You really do work hard to draw together salient statistics, ones that a proper and diligent government should be considering. However, mush as Bob J. suggests, there is no balanced view only the maintenance of the status quo. When external factors force the ante then we shall see interest rates coming up but only under duress.

    Paul

    • Hi Paul C and thanks

      These days it requires external pressure for an interest-rate rise which America excepted seems now to be the rule. After all the Swedes are cutting into a boom. No doubt the consequences will be presented as a surprise which couldn’t possibly have been expected!

  3. Hi Shaun, Thank you for another great post.
    Surely at some point the reduced investment in oil exploration and infrastructure today will come back to haunt us if a rapid increase in production is required to meet demand in future.
    It’s interesting the MSM are currently reporting we need to save twice as much for retirement. Maybe we wouldn’t need to if we could get any kind of reasonable return on our pension investments. I’m not sure I trust them with my money! The squeeze is continuing from all sides.

    • Hi Zummerzetman

      I do not know the lead times for conventional oil production but shale seems able to turn on a sixpence. What is required is a continuation of ultra-low interest-rates for the financing model and in spite of the fact that the US Fed intends to raise again maybe fairly soon we have a 10 year Treasury yield of only 1.85%. What an extraordinary world we are living in!

      The pension numbers are intriguing but the MSM as it rushes forwards seems to have forgotten that nobody sensible ever though that 7.5% of income ( I think I heard that quoted earlier) would be enough. Of course there will be more than a few reading this who think that 7.5% cannot be afforded. according to the Evening Standard it is not up north where things are grim.

      “In Camden, Wandsworth, Bromley and Richmond upon Thames, people may need to work until they are 80 to achieve their current living standards in retirement.”

      • Hi Shaun

        “I do not know the lead times for conventional oil production but shale seems able to turn on a sixpence.”

        I would think this is because shale oil/gas is almost if not entirely produced on land. Offshore production is another matter. Talking to industry friends in Aberdeen it is really brutal there at present. Almost all of them are now retired or soon retiring, with varying amounts of coercion. True most of them are at that age and will be looked after, but the many offspring who followed in their fathers’ footsteps have been badly hit. I was told that the government, which over the years has often ambushed the producers with extra taxes over and above what was agreed in advance, has done nothing at all to help, e.g. taking any of them off again. As a result the UK industry as a whole is currently running at a loss. It has reached the point where producers will very soon, be cutting their losses and moving out, in other words abandoning assets, selling offices, cutting loose staff, expertise and experience and so on. What this means in practice is that any revival will be far more expensive than simply un-mothballing operations. I wonder if any of this has given Nicola Sturgeon pause for thought?

  4. Hi Shaun

    Thank you for this blog that endorses very much that I have been thinking of late.
    As you say soon some high oil prices will drop out of the inflation figures to be replaced by weaker ones.However by next year this could the very opposite as very low prices are removed and probably higher or much higher prices come into play,
    Maybe after the referendum GBP could go higher as i can not evisage a vote for BREXIT.
    Inflation in the service section is high and may strengthened by the payment of the living wage to many workers.
    My concerns are by next year that wages will not keep up inflation and the BOE will nothing.

    • Hi Midge and thanks

      Your point about the National Living wage is well made. If we add that to the levels of service sector inflation which have survived a period of commodity price disinflation we see that the oil price will have to hit zero in 2019 for things to remain as they are. So in 2/3 months time as some of this wears off we will see the beginnings of a change unless oil and other commodity prices drop again.

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