UK Inflation looks set to fall as 2018 progresses

Today brings us face to face with the UK context on what many are telling us has been the cause of the recent troubled patch for world equity markets. This is because a whole raft of inflation data from the consumer producer and housing sector is due. The narrative that inflation has affected equities markets has got an airing in today’s Financial Times.

The inflation threat has simmered for months, but the missing link had been wage growth, which made the rise in the US jobs figures for January so important, fund managers say. Indeed, the yield on the 10-year Treasury is 40 basis points higher this year, driven almost entirely by inflation expectations. Strong global economic data, coupled with sweeping tax cuts and the recent expansionary budget deal in Washington, should stir price pressures.

Actually that argument seems to be one fitted after the events rather than before as the rise in bond yields could simply be seen as a response to the expansionary fiscal policy in the US combined with interest-rate increases and a reduction albeit small in the size of the Federal Reserve balance sheet. Actually as the FT admits inflation is often considered to be good for equities!

While faster inflation would typically be good for stocks, lifting companies’ pricing power and suggesting economic growth is accelerating.

Wages

There is also a theme doing the rounds about wage inflation. Yesterday Gertjan Vlieghe of the Bank of England joined this particular party according to Reuters.

 a pick-up in wages ……..signs of a pick-up in wages

The problem for the Bank of England on this front is two-fold. Firstly it has been like the boy ( and in some cases) girl who has cried wolf on this front and the second is that the official data has picked up no such thing so far. Thus we are left essentially with one higher wages print of 2.9% for average hourly earnings in the United States. So the case is still rather weak as we wonder if even the current economic recovery can boost wages in any meaningful sense.

Trends

The first trend which should first show in the producer price numbers is the strength of the UK Pound versus the US Dollar over the past year. It was if we look back about 14 cents lower than the current US $1.388. Also the price of crude oil has dipped back from the rally which took it up to US $70 in terms of the Brent benchmark to US $62.47 as I type this. This drop happened quite quickly after this.

Goldman Sachs has held one of the most optimistic views on the rebalancing of the oil market and oil prices in the near term, and the investment bank is now growing even more bullish, predicting that the oil market has likely balanced, and that Brent Crude will reach $82.50 a barrel within six months. ( OilPrice.com)

The Vampire Squid is building up quite a track record of calling the market in the wrong direction as back in the day it called for US $200 a barrel and when prices fell for a US dollar price in the teens. I will let readers decide for themselves whether it is simply incompetent or is taking us all for “muppets”.

Today’s data

The good news was that the trends discussed above are beginning to have an impact.

The headline rate of inflation for goods leaving the factory gate (output prices) rose 2.8% on the year to January 2018, down from 3.3% in December 2017…….Prices for materials and fuels (input prices) rose 4.7% on the year to January 2018, down from 5.4% in December 2017.

Tucked away was the news that the worst seems to be passing us as this is well below the 20.2% peak of this time last year.

The annual rate of inflation for imported materials and fuels was 3.5% in January 2018 (Table 2), down 1.7 percentage points from December 2017 and the lowest it has been since June 2016.

It is a little disappointing to see the Office for National Statistics repeat a mistake made by the Bank of England concentrating on the wrong exchange rate.

The sterling effective exchange rate index (ERI) rose to 79.0 in January 2018. On the year, the ERI was up 2.6% in January 2018 and was the fourth consecutive month where the ERI has shown positive growth.

Commodities are priced in US Dollars in the main.

Consumer Inflation

This showed an example of inflation being sticky.

The all items CPI annual rate is 3.0%, unchanged from last month.

However prices did fall on the month due to the January sales season mostly.

The all items CPI is 104.4, down from 104.9 in December

The inflation rate was unaffected because they fell at the same rate last year.

There was something unusual in what kept annual inflation at 3%.

The main upward contribution came from admission prices for attractions such as zoos and gardens, with prices falling by less than they did last year.

I will put in a complaint when I pass Battersea Park Childrens Zoo later! More hopeful for hard pressed budgets was this turn in food prices.

This effect came from prices for a wide range of types of food and drink, with the largest contribution coming from a fall in meat prices.

My friend who has gone vegan may be guilty of bad timing.

An ongoing disaster

The issue of how to deal with owner-occupied housing remains a scar on the UK inflation numbers. This is the way they are treated in the preferred establishment measure.

The OOH component annual rate is 1.2%, down from 1.3% last month. ( OOH = Owner Occupied Housing).

Not much is it, so how do they get to it? Well this is the major player.

Private rental prices paid by tenants in Great Britain rose by 1.1% in the 12 months to January 2018; this is down from 1.2% in December 2017.

If you are thinking that owner occupiers do not pay rent as they own it you are right. Sadly our official statisticians prefer a fantasy world that could be in an episode of The Outer Limits. They have had a lot of trouble measuring rents which means their fantasies diverge even more from ordinary reality.

If they had used something real then the numbers would look very different.

UK house prices rose 5.2% in the year to December 2017, up from 5.0% in November 2017.

This makes inflation look much lower than it really is and is the true purpose in my opinion. A powerful response to this at one of the public meetings pointed out that due to the popularity of leasing using rents for the car sector would be realistic ( they do not) but using it for owner-occupied housing is unrealistic ( they do).

If you want a lower inflation reading thought it does the trick.

The all items CPIH annual rate is 2.7%, unchanged from last month.

Comment

The underlying theme is that UK consumer inflation looks set to trend lower as 2018 progresses which is good news for both consumers and workers. The initial driving force of this was the rally of the UK Pound £ against the US Dollar and as it has faded back a little we have seen lower oil prices. We also get a sign that prices can fall combined with annual inflation.

The all items CPI is 104.4, down from 104.9 in December…..The all items RPI is 276.0, down from 278.1 in December…….The all items CPIH is 104.5, down from 105.0 in December.

One issue that continues to dog the numbers is the treatment of housing and for all the criticisms levelled at it a strength of the RPI is that it does have house prices ( via depreciation).

The all items RPI annual rate is 4.0%, down from 4.1% last month.

Meanwhile the Bank of England seems lost in its own land of confusion. It cut interest-rates into an inflation rise and then raised them into an expected fall! This is of course the wrong way round for a supposed inflation targeter. Now they seem to be trying to ramp up the rhetoric for more increases forgetting that they need to look 18 months ahead rather than in front of their nose. Perhaps they should take some time out and listen to Bananarama.

I thought I was smart but I soon found out
I didn’t know what life was all about
But then I learnt I must confess
That life is like a game of chess

 

 

Advertisements

11 thoughts on “UK Inflation looks set to fall as 2018 progresses

  1. Hello Shaun,

    I don’t think life is like a game of chess , more like monopoly but with all the spaces taken by the Bank , you join in and then what you can buy is what the bank has mortgaged – if you can afford it of course.

    So you see the only winner is the Bank ….

    Forbin

  2. There are at least two inflation rates and they affect different sub sets of people in different ways. The two rates I believe exist are financialised products such as mortgages and what I call real world goods such as baked beans or bread. For most goods all the inflationary potential is downwards, the world can basically supply anything and there is an all but infinite supply of labour.

    Of course inflation can’t be measured in the absence of Full Employment so any inflation figure is GIGO. The vast majority of people are just singing along to Gwen Guthrie, there ain’t nuthin going on except the rent.

    • “Of course inflation can’t be measured in the absence of Full Employment ..”

      oh bill I’m sure you’re being provocative – my popcorn is going up per pound is just a figment of my imagination because some guy in Manchester is out of work ?

      I can assure you that inflation in my figures I collect is very real indeed.

      I’m sure you can tell me that you’ve taken into account Minimum Operating Levels and Point of maximum Utility .

      back to Shaun’s article – yes both CPI and RPI are flawed and in my opinion with CPI calculated to have the lowest possible figure , for obvious reasons.

      Forbin

      • I’ll go one better than provocative and say all economics breaks down without Full Employment. MOL is a meaningless term in macro economics (they nicked it from engineering) and maximum utility is meaningless to the monoply currency issuer.
        Not all economics is macro just to be clear on terms here, but it ought to be the first duty of the state to ensure everyone has a job if they want one. What else is macro for?

  3. As ever Shaun,many thanks for your continued coverage of the scandal-and I use the word knowingly-that is the ongoing treatment of housing in inflation figures.

    It’s breathtaking to think that the purchase price of a house if excluded when the property ponzi has created so much damage (much of which we’re yet to see) demographically-lower fertility rates and socially-intergenerational transfers of wealth.

    I also wonder whether I’m naieve in wondering whether the govt should start measuring inflation specifically for household income deciles.I can’t be alone in thinking that the inflation rate for a minimum wage household is signifcantly different to that experienced by a middle income household especially with the treatment of food and fuel and the ironically named ‘core’ inflation data.

    • Don’t worry, Dutch, with house price increases fizzling out I’m sure the ONS will want to include them in place of the flawed (i.e. ‘higher’) rental equivalent figures.

  4. Great blog as usual, Shaun. Thank you for keeping the heat up on the ONS “headline” measure of inflation, CPIH.
    When he was testifying before the Economics Affairs Committee of the House of Lords Carney told Lord Burns: “The BoE’s view of the precise wedge between RPI and CPI is different. The market is wonderfully sophisticated in many respects, but sometimes it says, ‘Oh it is about 1%’. Our view is that it is 70 basis points.”
    As you pointed out in today’s blog, the CPI inflation rate for January was 3.0% and the RPI inflation rate was 4.0%, so the wedge wasn’t about 1%, it was 1.0%, and substantially above 70 basis points. It has averaged 85 basis points from April 2010 forward. It seems odd that Carney would insist on such a low value for the wedge. If it were really that low then it means that for 2018Q1 the five-to-ten-year-ahead expectation of the financial markets of an RPI inflation rate of 3.5% are equivalent to an expectations for the CPI inflation rate of 2.8%. “Well anchored” inflation expectations, indeed!

    • Hi Andrew and its a pleasure

      I think that Governor Carney was trying to seem clever and it may have worked in the meeting but I have my doubts. It seems to me more likely that the Bank thinks the formula effect is 0.7% which means RPIJ would be 3.3%. Of course he does not actually want to say that or refer to RPIJ in case somebody asks what happened to RPIJ as it was an interesting idea?

      Also this raises the issue which I have pointed out many times that the change in the inflation target from RPI at 2.5% to CPI at 2% was a loosening of policy.

  5. The rise in UK HPI inflation in December that you mentioned may well be linked to the cut in stamp duty for first time buyers that came into effect on November 22. There was a 0.4% monthly increase in the HPI, as opposed to a 0.2% increase last December, and that accounted for the annual HPI inflation rate rising from 5.0% to 5.2%. There is a one-month lag in the RPI incorporating these house price data, and there is also a not clearly justified exponential smoothing of the house prices. As a result, the depreciation index showed a 0.6% increase in January 2018, up from 0.2% in January 2017, and the annual inflation rate for depreciation went from 3.7% to 4.2%.
    As household-oriented measures the CPI and CPIH) are both dysfunctional, as you say, because they ignore house prices. On the other hand, the RPI is also dysfunctional , because of the formula effect, which gives it an upward bias. The RPIJ corrects for that and would show a 3.3% inflation rate, down from 3.4% in December, if it were still published. However, it ignores stamp duty, whose index would be pushed up over the last year by the house price increases and the increase in the effective average stamp duty rate the price increases would entail, but at the same time dragged down by the cut for first time buyers. Since for now we can’t correct for this, a best provisional estimate would be that as a household-based measure the CPI underestimates inflation (as compared to the RPIJ) by 0.3 percentage points and the hapless CPIH underestimates it by 0.6 percentage points.
    The household inflation index John Astin and Jill Leyland proposed was like a new and improved RPIJ. With respect to owner-occupied housing it would have incorporated stamp duty and replaced the depreciation component with an index of equity payments on the home, also pricing renovations. It would have been perfect. However the household cost indices that the ONS has actually published only include the stamp duty component; the rest of the package isn’t there. And although the HCIs are monthly, they aren’t even updated every month. So there is no published index now, not the HCIs, not the CPI, not the CPIH, not the RPI, that UK households can currently trust in and say it provides a reliable index for upratings. Maybe the HCIs will fulfill that role in future, but they will have to change, and we are talking about substantial changes, not minor tweaks.

  6. “The underlying theme is that UK consumer inflation looks set to trend lower as 2018 progresses”

    Yes but not below 2.6% so hardly a trend due to narrow money growth in 2015 as I posted in December that year the BOE should have been ramping up rates then but they didn’t and now the labour market looks tight. I’m hearing anecdotally that EU immigrants have started migrating back home ahead of Brexit which will make the labour market ever tighter. Inflation wouild be higher but that the $ has entered it’s weakening phase which will stay for at least a couple of years.

    BOE should hang fire on any further raises now until the collapsing money supply reverses. The time to raise was 2 years ago.

Leave a Reply

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

WordPress.com Logo

You are commenting using your WordPress.com 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 )

w

Connecting to %s