This week brought some disappointing news for the Bank of England. If we go back to Monday we were told this.
LONDON (Reuters) – British households’ expectations for inflation over the next 12 months rose to 2.8% in July from 2.6% in June, according to a survey from U.S. investment bank Citi and pollsters YouGov.
Longer-term inflation expectations rose to 3.4% from 3.3% in June, the Citi/YouGov survey of 2,011 adults showed.
“Rising inflation expectations should … support hawks at the (Bank of England),” Citi economists Christian Schulz and Ann O’Kelly said.
There are two problems there for the Bank of England. The first is that expectations imply that people think that inflation is above the 2% target and has been so. This is an implied defeat for the enormous effort that it and other parts of the UK establishment have put it getting our official statisticians have put into getting the Imputed Rent driven CPIH as the headline inflation measure.
Even worse the measure of future expectations has risen. This shows two factors at play. One is rhetoric as we are subjected to a media barrage about future falls in the UK Pound £ exchange rate. The other is the reality that the UK Pound £ has been in a weak phase and in inflation terms this is best represented by the rate against the US Dollar because it is the currency in which nearly all commodities are priced. Whilst it is relatively stable this morning at US $1.2060. Whereas if we go back a bit over 3 months to the early part of May we see that it was some 11 cents higher. Over the past year it is some 5.5% lower so we can see that there is some commodity price pressure on the cards so well done to the ordinary person surveyed for inflation expectations.
Producer Price Inflation
We can find out what is coming down the inflation pipeline from these numbers.
The headline rate of output inflation for goods leaving the factory gate was 1.8% on the year to July 2019, up from 1.6% in June 2019…….The growth rate of prices for materials and fuels used in the manufacturing process was 1.3% on the year to July 2019, up from 0.3% in June 2019.
This is a change as the previous overall trend was for both input and output inflation to be falling. The main area is a little awkward so let us look at it.
On the month, crude oil provided the largest positive contribution of 0.30 percentage points with monthly growth of 1.8%. This is a 9.3 percentage points increase following negative growth of 7.5% in June 2019.
This is because the lower UK Pound has been a constant influence but the oil price has been ebbing and flowing to some extent mirroring the tweets of President Trump on the trade war. For example yesterday it rose 3/4% as he announced delays in planned tariffs on China. So the outlook with Brent Crude around US $61 per barrel is for it to have a small disinflationary impact looking ahead but the trend may change with one tweet.
Also do any of you have thoughts on this? The subject is on my mind anyway after last Friday’s power cut in Battersea.
This growth was mainly driven by electricity production and distribution, which increased 20.1% on the year to July 2019, the highest the rate has been since records began in 2009.
Here the situation looks calm on the surface but there are two serious problems below it.
The Consumer Prices Index (CPI) 12-month rate was 2.1% in July 2019, increasing from 2.0% in June 2019.
In a world where US President Trump describes a 0.3% monthly and 1.8% annual increase like this I am not sure where this puts us!
Prices not up, no inflation.
Anyway if we return to the UK we see that a problem I have warned about before is back.
The largest upward contribution (of 0.08 percentage points) to change in the CPIH 12-month rate came from recreation and culture. Within this group, the largest effect came from games, toys and hobbies (in particular from computer games and consoles) where prices overall rose by 8.4% between June and July 2019 compared with a rise of 4.1% between the same two months a year ago.
Here is the confession that we are blundering in the dark here.
Price movements for these items can often be relatively large depending on the composition of bestseller charts and the upward contribution between the latest two months follows a downward contribution, from computer games purchased online and games consoles, between May and June 2019.
This matters because it highlights a systemic problem. A similar problem is in play with fashion clothing. Rather than doing something about it the UK establishment has been using the latter problem as a tool for beating the Retail Price Index with. Rather than research and reflection we get rhetoric.
Retail Price Index
Speaking of the RPI the annual rate fell to 2.8% which is partially good news for rail passengers because the rate at which regulated fares rise will be that. At east it is below the rate of wages increases. But there is a problem here too.
An error has been identified in the Retail Prices Index (RPI) in 2019, caused by an issue with the 2017 to 2018 Living Costs and Food Survey (LCF)dataset, which is used to produce the weights underpinning the RPI.
Indicative estimates show that if the corrected LCF dataset had been used to calculate the 2019 RPI weights, it would have led to an upward revision of 0.1 percentage points to the published RPI annual growth rate in March 2019, from 2.4% as currently published to 2.5% and a downward revision of 0.1 percentage points to the June 2019 rate, from 2.9% as currently published to 2.8%. No other month’s annual growth rates have been affected.
It is a good job that large amounts of financial contracts do not depend on this, Oh wait! But these numbers also matter in themselves.
There was some excellent news here.
Average house prices in the UK increased by 0.9% in the year to June 2019, unchanged from May 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 2.7% over the year to June 2019, less than the 3.1% fall in May 2019. Average house prices in London have now been falling over the year each month since March 2018.
With wage growth at 3.7% finally houses are on average becoming more affordable. As the London numbers highlight there are regional disparities though. On the other side of the coin house prices in Wales rose by 4.4%.
I have a couple of serious points to make so let me start with some humour courtesy of The Guardian.
City economists had forecast CPI to fall to 1.9% – instead, it’s now over the Bank’s target of 2%.
The unexpected rise could pile pressure on Threadneedle Street to raise interest rates, even as economic growth falters…
Meanwhile the problems with how we measure inflation in the UK pile up as computer game are added to the problems with fashion clothing. Yet the UK Statistics Authority and the ONS have instead spent their time joining the establishment campaign against the RPI. Please do not misunderstand me as I have a lot of sympathy with the ordinary statisticians who in my experience are doing their best, but it was hard not to have a wry smile this morning at us getting the numbers wrong and creating their worst nightmare a “discontinuity”.
If we look wider we see that there are problems elsewhere as the changes to package holiday prices showed in Germany and in the wider Euro area inflation data. That will impact the GDP numbers via the deflator. Ironically with an RPI style inflation measure or perhaps based on the new HII/HCI the UK could be in good shape here.
Let me give another perspective by quoting Paul Johnson of the IFS in Prospect Magazine from February.
A version of it, CPIH, takes account of owner occupiers’ housing costs and is the one that the statisticians would like us to use. But it is of relatively recent vintage and hasn’t really caught on yet.
He seems to have forgotten that it was the Johnson Review ( yes him) that recommended this in 2016.
ONS should move towards making CPIH its main measure of inflation. In the meantime, the CPI should continue to be the main measure of inflation.