The UK finds itself facing quite a few economic changes as it moves forward. One of the most immediate has been the change in the value of the UK Pound £ as it fell heavily as the result of the Brexit referendum emerged. This will have an inflationary impact on the economy as we wonder how much? The Bank of England rule for currency changes does not help much here but we do have one provided by Mario Draghi of the ECB. Back on the 3rd of May I reminded us of it.
A couple of years ago we did get a “Draghi Rule” for measuring the impact of all this…….Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.
How much of a fall have we had? If we keep to round numbers then in terms of the trade weighted or effective exchange rate the UK Pound £ has fallen by 8% since the referendum result emerged. Applying the Draghi Rule would see an increase in inflation of 0.3% to 0.4%. If we look at the way that the UK economy is relatively more open than the Euro area and the fact that our fall was more against the US Dollar in which many commodities are priced I expect a larger impact on the annual rate of inflation than the Draghi Rule implies and estimate one of say 1%.
What is the commodity background?
We also need to look at the commodity price background to see if it will reinforce the upwards trend or weaken it. Some good news comes from the price of crude oil which was rising in the spring but has lost momentum in the summer. So whilst it is up in 2016 so far by 23% it is also some 18% lower than this time last year as we note it has fallen by 8% in July so far. So should Brent Crude Oil remain at US $47 or so it will not be reinforcing the inflationary burst.
The other commodity price news is less good as the CRB index has risen from 375 to 415 so far in 2016. This means that it is pretty much where it was this time last year. If we look for what has driven the change then the metals sub index has risen from 556 to 702 so far this year. Other pictures are more mixed as for example a popcorn consumer will cheer lower corn prices but be less happy about rises in the price of the oils it is cooked in. Prices for meats were rising but this year has seen record pork production in the US so pork prices have dipped recently.
What about wages?
This is of course the dog that has not barked so far in the UK economic recovery. Accordingly fears of a 1970s style wages and prices spiral seem like from another world if not universe. As I discussed yesterday this has been a very different type of recovery and wages were struggling to grow pre credit crunch.
Here are the headlines.
The all items CPI annual rate is 0.5%, up from 0.3% in May.
This was higher than economist expectations and the cause was especially embarrassing as higher air fares for the Euro 2016 tournament would surprise almost nobody else.
Within transport, the largest upward effect came from air fares which rose by more than a year ago, with the main contribution coming from European routes. The 10.9% rise in fares this year was the largest May to June movement on record although it is important to note that air fares are highly variable.
There was also something that has become rather familiar.
The CPI all services index annual rate is 2.8%, up from 2.6% last month………The CPI all goods index annual rate is -1.6%, up from -1.8% last month.
The services sector has seen inflation above the target for some time now and this is also an international theme as I see it elsewhere ( most recently in the US CPI release). However the continuing good price disinflation is keeping overall inflation low and still close to zero.
What is the outlook?
If we move to the producer price series then the effect of past oil price falls and indeed other commodiities is fading and some of the commodity price rises I discuss above are coming into play.
Factory gate prices (output prices) for goods produced by UK manufacturers fell 0.4% in the year to June 2016, compared with a fall of 0.6% in the year to May 2016.
This was seen even more at the input level.
The overall price of materials and fuels bought by UK manufacturers for processing (total input prices) fell 0.5% in the year to June 2016, up from a fall of 4.4% in the year to May 2016.
There were various factors at play here. firstly the consequence of the rise in the price of crude oil in 2016 ( as the more recent fall was yet to happen) and more expensive food both from the UK and abroad.
Home-produced food prices increased 6.7% in the year to June 2016, compared with a rise of 3.0% last month…… The main contribution to this movement was from crop and animal production which increased 6.1% in the year to June 2016 and 0.1% between May and June 2016.
I am loath to blame the weather but will those with more knowledge of agriculture please let me know if the wet weather was a factor here?
These seem to have completely ignored the expectations of a dip as the buy to let surge ( to escape a Stamp Duty Tax rise) faded and ended.
UK average house prices have increased by 8.1% in the year to May 2016 (unchanged from the year to April 2016), continuing the strong growth seen since the end of 2013.
Ah yes! Since the Funding for Lending Scheme came into full force. As ever we see very different swings in prices as well as extraordinary differences. Let us start with a quite extraordinary difference.
In May 2016, the most expensive borough to live in was Kensington and Chelsea, where the cost of an average house was £1.27 million. In contrast, the cheapest area to purchase a property was Burnley, where an average house cost £69,000.
Just the 18.4 times higher! Also very different rates of change.
The local authority showing the largest annual growth in the year to May 2016 was Slough, where prices increased by 23.3% to stand at £287,000. The lowest annual growth was recorded in the City of London, where prices fell by 9.2% to stand at £692,000.
Perhaps there are fans of the TV series The Office are buying and people have forgotten the words of Ali G and indeed John Betjeman. It is interesting to see prices fall in the City of London and I will scan the data later to see if we can glean any news on the area around Nine Elms.
Of course this is all pre Brexit but if you want some post Brexit views well here is one via Ed Conway of Sky.
Whoa. SocGen: house prices in London’s most expensive areas could halve in the wake of Brexit
I did point out that a lot of people (first time buyers for example) would welcome that.
If we now look to bring everything together we see that the UK looks set to see a rise in inflation as 2016 progresses. Regular readers will be aware that I expected a rise in the annual rate in the autumn anyway as past goods disinflation fades and services inflation carries on. That theme has now seen a boost of the order of 1% per annum from the initial Brexit leave vote effect. That of course is an initial estimate as we do not know what if any second order effects there will be. Also I am assuming that the UK Pound £ remains at its current level and whilst it seems more stable now that could easily change. Rises in its value would weaken the effect and falls strengthen it.
That will feed into a reduction in real wage growth which returns me to my theme of yesterday. Meanwhile of course if you put house prices into the inflation numbers you would argue that it was not so low in the first place. You can argue about weights but a proper UK CPI would be of the order of 1.5% right now if you put house prices in. As that happens the indicator which takes a lot of official scorn seems to be in the right area!
The all items RPI annual rate is 1.6%, up from 1.4% last month.