Yesterday Bank of England Governor Mark Carney spoke at the ECB summer conference in sunny Sintra Portugal. Tucked away in a speech mostly about the Euro was a reference to the problems the Bank of England has had with inflation as you can see below.
While the euro area has continued to experience ‘divine
coincidence’ the UK has not (Chart 1). In the euro area, inflation has averaged half a point below target,
reflecting in part the drag from persistent slack in the labour market. In contrast, UK inflation has been above
target, averaging 2.3%, during a period where the economy was operating well below potential.
Over such a period that is quite a difference and for the moment I will simply point out that he has no idea about the “potential” of the UK economy as his speech later inadvertently reveals. But let us move on to his explanation.
That reflects the inflationary impacts of two large exchange rate depreciations and weak productivity that have
offset a major positive shock to labour supply. This has created tensions between short-term output and
inflation stabilisation in the UK that have not been evident in other major economic regions.
Missing from his explanation is the way that expectations of easier policy from the Bank of England helped drive both “large exchange rate depreciations”. The 2007/08 one pre dates his tenure at the Bank of England but the post EU Leave vote one was on his watch. I still come across people who think he pumped £500 billion into the UK economy on the following morning rather than getting the ammunition locker ready. But he did cut interest-rates ( after promising to raise them) and pour money into the UK Gilt Market with £60 billion of Sledgehammer QE purchases.
So rather than something which just happened he and the Bank of England gave it a good shove and that is before we add in that he planned even more including a cut to a Bank Rate of 0.1% that November. That did not happen because it rapidly became apparent that the Bank of England had completely misread the UK economic situation. But by then the damage had been done to the UK Pound which was pushed lower than it would otherwise have done.
We get an implicit confirmation of that from this.
Since 2013, the MPC’s remit has explicitly recognised that there are circumstances in which bringing inflation
back to target too quickly could cause undesirable volatility in output and employment.
In other words in a world where inflation is lower than before it is no longer an inflation targeter and instead mostly targets GDP. Actually we get a confession of this and a confirmation of a point I have made many times on here as we note this bit.
Indeed, on the basis of this past behaviour in the great moderation, the MPC would have raised interest rates by 2 to 3 percentage points between August 2013 and the end of 2014.
Due to the international environment with the Euro area heading for negative interest-rates that would have been to much, But we could have say moved from 0.5% to 1.5% as I have regularly argued and would have put ourselves on a better path. Oh and I did say that Governor Carney has no idea of the potential of the UK economy, so here that is in his own words.
What we – and others – learnt as the recovery progressed was that the UK economy had substantially more
spare capacity than previously thought.
It is hard not to have a wry smile at UK inflation being bang on target after noting the above.
The Consumer Prices Index (CPI) 12-month rate was 2.0% in May 2019, down from 2.1% in April 2019.
Tucked away in the detail was something which should be no surprise if we note the state of play in the car industry.
there were also smaller downward contributions from the purchase of vehicles (second-hand and new cars).
The other factor was lower transport costs as air fares fell mostly due to the Easter timing effect and the cost of diesel in particular rose more slowly than last year. On the other side of the coin was something which has become very volatile and thus a problem for our statisticians.
Price movements for computer games can often be relatively large depending on the composition of bestseller charts.
Looking for future trend we see what looks like a relatively benign situation.
The headline rate of output inflation for goods leaving the factory gate was 1.8% on the year to May 2019, down from 2.1% in April 2019.
There had been worries about the input inflation rate which picked up last time around but the oil price seems to have come to the rescue for now at least.
Petroleum provided the largest downward contribution to the change in the annual rate of output inflation. The annual rate of input inflation fell 3.2 percentage points in May 2019, driven by a large downward contribution to the change in the rate from crude oil.
Welcome news from house prices
If we switch to this area we see that the slow down in the annual rate of growth continues.
Average house prices in the UK increased by 1.4% in the year to April 2019, down from 1.6% in March 2019 . Over the past three years, there has been a general slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.
The lowest annual growth was in London, where prices fell by 1.2% over the year to April 2019, up from a fall of 2.5% in March 2019.
I am pleased to see that as the best form of help for prospective buyers is for wage growth ( currently around 3%) to exceed house price growth. There is a lot of ground to be gained but at least we are making a start.
There is an irony here as I note that for once this will be similar to the number for rents that are being imputed as the inflation measure for owner-occupiers. Yes for newer readers you do have that right as the official CPIH inflation measure assumes that those who by definition do not pay rent rush out and act as if they do.
Private rental prices paid by tenants in the UK rose by 1.3% in the 12 months to May 2019, up from 1.2% in April 2019.
The problem for CPIH is that we have had an extraordinary house price boom without it picking anything up, so this is an anomaly and is unlikely to last.
There is a sort of irony in UK inflation being on target in spite of the fact that the Bank of England has mostly lost interest in it. The credit crunch era has seen other examples of this sort of thing which echoes when the Belgian economy did rather well when it had no government. We might well be better off if we sent the Monetary Policy Committee on a long holiday.
At the moment there have been quite a few welcome developments in this area. Because wage growth is positive compared to both CPI inflation and house prices after sustained periods of falls. Some caution is required as the RPI is still running at an annual rate of growth of 3% but we are in sunnier climes.There are troubles in other areas as the lower car prices highlight so we need to grab what we can.
Let me finish with a thank you to the Guardian for quoting me in their business live blog and for providing some humour.
Today’s drop in inflation means there’s no chance of the Bank of England raising interest rates on Thursday, say City economists.
Where have those people been in the credit crunch era?