UK inflation measurement is in crisis

It is Wednesday so it is inflation numbers day in the UK. If that feels a little out of key then you are right as they used to be on a Tuesday and the labour market data set followed the next day. But in a sad indictment of our rulers it was decided that releasing the labour market numbers at 9:30 today did not give then enough time to spin, excuse me, analyse the numbers in time for Prime Ministers Questions at lunchtime. The theme of being out of tune though continues today as we note the ongoing problems in simply collecting the prices.

As a result of the ongoing coronavirus (COVID-19) pandemic, we identified 74 CPIH items (or 14.2% of the CPIH basket by weight) that were unavailable to UK consumers in May, as detailed in table 58 of the Consumer price inflation dataset; this is down from 90 unavailable items in April; compared with the February 2020 index (the most recent “normal” collection), we have collected a weighted total of 81.6% (excluding unavailable items) of the number of price quotes for the May 2020 index, although the coverage varies across the range of items.

There is a clear issue with being unable to collect some of the data. Added to that is the fact that prices which are unavailable are likely to be the ones which have risen in price. For example the new HDP ( High Demand Products) measure had to drop out things like face masks and hand sanitiser for a while which introduces a downwards bias to the reading. What happens when they cannot record something? Well let me hand you over to the BBC explanation.

The ONS admitted that it had difficulty compiling inflation statistics for May, since many areas of the economy were completely shut down.

For instance, inflation figures for holidays had had to be “imputed”, it said.

Of course some will be pleased by this as there is a lot of official enthusiasm for imputing prices as they have demonstrated in the area of rents. For newer readers the official CPIH measure uses fantasy rents to impute owner-occupied housing costs. This is the reason in spite of all the official effort it remains widely ignored as I doubt anyone charges themselves rent to live in their own home. Even worse they have had real trouble measuring actual rents and you do not have to take my word for it,just read the release from earlier this week.

To achieve this, completely new innovative methodology will be needed. In October 2019, we started building a prototype using a new methodology with the capability to meet the aims specified in Section 3.

Perhaps we will get inflation numbers with this year’s rents rather than last years? It is rather conspicuous that they have failed to answer my question on this subject

Today’s Data

A further fall was recorded in terms of the annual rate

The all items CPI annual rate is 0.5%, down from 0.8% in April……The all items CPI is 108.5, unchanged from last month.

As you can see prices were unchanged on a monthly basis although there were shifts in the structure.

The CPI all goods index annual rate is -0.9%, down from -0.4% last month……The CPI all services index annual rate is 1.9%, down from 2.0% last month.

That is intriguing as we see disinflation in the good sector but not that much impact at all on services.That teaches us a little about pricing in that sector as it has seen a volume drop that for once justifies the word collapse and yet the pricing impact has been small. Looking at specific areas we see this.

Transport, where the price of motor fuels fell this year but rose a year ago, contributing 0.12 percentage points to the easing in the headline rate. Petrol prices fell by 2.8 pence per litre between April and May 2020, compared with a rise of 4.2 pence per litre between the same two months a year ago. Similarly, diesel prices fell by 2.6 pence per litre this year, compared with a rise of 2.8 pence per litre a year ago.

I doubt any of you are surprised by this and it was joined by Recreation and Culture which is of note as a problem area popped up again.

Within this broad
group, there was a downward contribution (of 0.06 percentage points) from games, toys
and hobbies, with the effect coming from a variety of traditional toys and games, plus
computer games consoles and computer games

For newer readers this is the effect of computer games being discounted when they go out of fashion which the numbers struggle to cope with.Fashion clothing has the same problem and actually in an odd link led to them trying to neuter the RPI. Next we get an attempt at humour, at least I hope it is humour.

Health, where prices overall fell by 1.4% this year compared with a rise of 0.2% a year ago.
The effect came from pharmaceutical products, particularly pain killers and antihistamine
tablets, and other medical and therapeutic products, particularly daily disposable soft
contact lenses.

Does anybody believe health costs are falling?

On the other side of the coin was this.

Food and non-alcoholic beverages, with prices rising by 0.5% this year compared with a smaller rise of 0.1% a year ago.

The details are for the CPIH measure because our statistical establishment is so desperate to get it a mention they only break the numbers down for it. From the point of view of the Bank of England Governor Andrew Bailey can add the new CPI number to the letter he is presently composing to the Chancellor to explain why it is more than 1% below target. His quill pen is probably being dipped into the Bank of England official ink no doubt being held by a flunkey right now as he explains how he will expand QE by another £100 billion or so in response. That is something of a Space Oddity as of course QE will boost the asset prices it ignores. Oh well! As Fleetwood Mac would say.

Retail Prices Index

This too saw a fall in the annual rate.

The all items RPI annual rate is 1.0%, down from 1.5% last month……..The all items RPI is 292.2, down from 292.6 in April.

I note that on a monthly basis the RPI fell. If it did that more often it would quickly be back in official favour! Also even under the old system the Governor of the Bank of England would have to get his quill pen out.

The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is
1.3%, down from 1.6% last month

As to credibility of our inflation numbers I am afraid this is another downgrade.

The published RPI annual growth rate for April 2020 was 1.5%. If the index were to be recalculated
using the correct interest rate, it would reduce the RPI annual growth rate by 0.1 percentage points
to 1.4%.

To get mortgage rates wrong is really rather poor and it was not the only mistake.

In addition, an error has been identified in the adjustment made to reflect a change in product size
for a single price quote for “canned tuna” collected in April 2020.

Comment

As you can see there is a large amount of doubt about the inflation numbers right now. This has not stopped much of the media from already setting the scene for more monetary policy easing. The Bank of England votes later today and it has the problem that the Deputy Governor for this area Ben Broadbent has actively demonstrated a wide-ranging ignorance of the issues. Just as a reminder I expect them to vote for at least another £100 billion of QE bond buying. This is in spite of the fact that the asset prices it will boost are ignored by the CPI inflation measure they target.

Meanwhile some new research has suggested that prices are in fact rising more quickly, and the emphasis is mine.

In this paper, we use detailed scanner data to provide a portrait of inflation during the Great Lockdown, covering millions of transactions in the UK fast-moving
consumer goods sector. We find that there was an unprecedented spike in inflation at the beginning of lockdown, which coincided with a reduction in product variety.

Indeed there was more.

The price increases we found for many categories, including those not subject to demand spikes, indicate supply disruptions and changes in market power may be playing an important role.

This has a consequence.

Many households are subject to reduced
income and liquid wealth, and higher prices for foods, drinks and household goods
will feed into squeezed household budgets

Here are the numbers.

First, we find that in the first month of lockdown month-to-month inflation was
2.4%. This sharp upturn in inflation is unprecedented across the preceding eight
year

So thank you to Xavier Jaravel and Martin O’Connell for this paper which suggests that as well as Fake News we also have to contend with fake official statistics.

The Investing Channel

21 thoughts on “UK inflation measurement is in crisis

  1. Ludwig Von Mises predicted the scenario that is playing out now, called it the crack up boom where the stockmarket goes vertical in the final blowoff phase and is accompanied by the collapse of the currency, you can be sure the Bank of England will be steering us towards that cliff most carefully

    • Hi Kevin

      “you can be sure the Bank of England will be steering us towards that cliff most carefully…”

      like this ?

      Forbin

      • How come it ends with “Fin” and not with “The End”? Was Ridley Scott putting on airs? Does he consider himself an auteur?

  2. However there are some more stats which may concern the BOE PPI inflation -10% and that is the lowest number for a long long time:

    https://uk.investing.com/economic-calendar/ppi-input-729

    I suspected inflation numbers were on a downward trend and these numbers are indicative of a deflationary world economy imo.

    They may add fuel to the fire in BOE rates going negative. Good news and bad news as low interest rates will benefit borrowers but debt will not be depreciating.

    Bad news for pensioners as triple lock will become useless particularly if wage inflation collapses as well and the figures yesterday indicated wage inflation was collapsing.

    The only befit in the short tern has been the stock market bouncing back but how long this will go on for is questionable if companies then follow and go to the wall once money dries up which could happen, then property prices collapse.

    This would be the worst case scenario but not impossible.

    • Without the cost of putting a roof over ones head crashing the economy will never recover.

      So your comment about house prices collapsing is the best case scenario.

      Just think all that money people would have to put into their local economy if their rent/mortgage halved.

      • Arthur,

        But most people on fixed rate mortgages so regardless of interest rate falls it wont make any difference whether or not rates go negative.

    • Shaun with regards to your comments on inflation:
      “Meanwhile some new research has suggested that prices are in fact rising more quickly, and the emphasis is mine.”

      During lockdown many of the Supermarkets abandoned their buy one get one free offers as there was a rush buying up as many essentials due to stockpiling.

      This probably meant consumers have seen inflation contrary to the methodology the ONS has used.

      There is no perfect system however as there are too many variables.

      Going forward I suspect most people will have bought most of their computer related and entertainment needs while in lockdown and these prices may become more competive in future putting further downward pressure on prices imo.

  3. Given that these inflation figures are not really worth the paper they are written on and prices of consumer goods have risen due to supply issues, maybe we should just be truthful and have a ‘bog roll’ index?

    At the moment, I am working on locating beneficiaries of deceased account holders. One quick check is to look up the address on Rightmove to see if the contact is still there. I am just staggered by prices in the south-east and areas of London once considered pretty rough. Prices in London must be ten times the level when my late great aunt’s house in south Fulham was sold in 87 and even then it went for treble the death valuation at the end of 81. It is just a giant vortex sucking consumption demand out of the economy.

    Inflation is a demand phenomenon where productivity does not rise – there will be supply shocks, be it oil or bog roll, but the demand simply shifts. Bogof offers may have gone on bog roll, but local shops to me have a lot of strawberries on offer. One interesting guide for me has been Ambrosia rice pudding, usually priced at 75p, although sometimes there are offers down to 50p.At the start of lockdown, they went to £1, but they are now back at 75p. So, with the steep fall in wages and rising unemployment (5.1% if you include the inactive figures as Shaun said), then demand has tanked. I suspect we might also see some price inflation as demand initially outstrips supply and sellers try to recover some lost profit (it is well-known economic theory that you can keep going for a while just covering your variable costs, but somewhere down the line, you need more revenue to pay the fixed costs). Oil will recover to its former level, which will put pressure on inflation. So, we are going to see some “looking through” inflation as a further excuse to keep pumping up house prices, sorry, erm, stimulate the economy.

    • Hi

      The banks are expecting a property crash and are withdrawing mortgage products. Nationwide now require a 15% deposit.

      So I’m expecting the boe to step in with more insane housing policies. i feel for the muppets who went for HTB. They could be stuck with a SVR they cant remortgage and the rental side will be kicking in. If the banks had done this it would be fraud.
      Not so for our property pumping government.

  4. Outbreaks of virus in German slaughterhouses and meat packaging factory in Anglesey who supply KFC and Tesco, will probably result in higher prices.People working to close together and more costs likely as this will be closely monitored

  5. Hello Shaun

    Others have postulated that we’d have a “L” shaped recovery but I did wonder if we’d see more of a “W” shaped one with the last rise lower. That is we’d see a bounce back from lock down due to exuberance then as September and October roll in that fades away to the realities of unemployment and recession ( if not the “D” word ), followed by a smaller rebound then downwards again for Christmas.

    Lord knows I’ve been wrong in the past , perhaps this time too but it don’t look good , no when they “impute ” things all the time instead of admitting the data is crap and they don’t know…..

    Forbin

  6. Great blog as usual, Shaun.
    The big drop in the CPI inflation rate in May can serve as a useful example of the threat that temporary price level targeting could pose to those who favour low inflation for the UK. The annual inflation rate for May 2020 is 0.5%, well below the 2.0% target. A temporary price level targeting scenario that would require the Bank of England to target a price level target compatible with 2.0% inflation over the period from May 2019 to May 2022 would require an inflation rate of 2.7% annualized between May 2020 and May 2022, i.e. substantially in excess of the 2.0% target rate. This would differ from the current practice, where one essentially forgets about what happens in the past and aims for a 2.0% inflation rate going forward. If one treats the May 2019 to May 2020 inflation experience as an aberration, and attained a 2.0% inflation rate over the period May 2019 to May 2022, the average annualized inflation rate over the entire three-year period would be just over 1.5%, which is less than the target inflation rate, but seems to be the kind of deviance that only a deflation nutter would worry about.
    Suppose that between May 2022 and May 2023, one had instead a positive shock to the inflation rate, taking it to 3.5%. (It is hardly unrealistic; this was the CPI inflation rate as recently as March 2012.) Since we are not in zero lower bound territory, we would now be back in the normal inflation targeting world, and this deviation would be ignored, the goal being to hit the 2% target thereafter. If the 2.0% target were achieved over the next two years the average inflation rate over the whole period May 2019 to May 2025 would be 2.2%, rather than the target 2.0% rate.
    Note that even assuming that temporary price level targeting doesn’t dislodge inflationary expectations, making inflation more difficult to control, it could lead to a not inconsiderable increase in the average inflation rate over a number of years. And of course, if it did dislodge inflationary expectations, the inflationary impact could be much more severe.
    It would be much easier to impose such a temporary price level targeting regime in the UK than in, say New Zealand. The freedom of action of the Chancellor of the Exchequer is not constrained by a Policy Targets Agreement with the central bank governor as is the case with the New Zealand Finance Minister. Mr. Sunak just has to decide that this is what he likes and issue a new remit to the Governor of the Bank of England.

    • Hi Andrew and thank you.

      The 0.5% CPI inflation rate poses a few questions as the reading was driven lower by a transport sector which is fairly heavily over weighted at the moment. As time passes we will discover in my opinion that inflation was under recorded and maybe heavily so which is awkward. That is before the issue of how can you claim to have price-level targeting when you have been unable to collect towards 30% of the prices.

      Your point about the Kiwis is interesting. The UK remit position became more active under Chancellor Osborne and may be related to the role of the Treasury rising as it backs any QE expansion. As the RBNZ is now on the QE road I wonder if its regime will see some changes too.

      “The Monetary Policy Committee has agreed to significantly expand the Large Scale Asset Purchase (LSAP) programme potential to $60 billion, up from the previous $33 billion limit. The LSAP programme includes NZ Government Bonds, Local Government Funding Agency Bonds and, now, NZ Government Inflation-Indexed Bonds.”

      Only time will tell….

      • ’bout time NZ joined the rest of the world – it’s been missing all the fun for years.

        No-one is talking about inflation here. It’s all about jobs and the economy.

        Time will indeed tell.

        Main Item in the News today is about free trade talks with the UK.

  7. The simple answer is to measure the inflation of the goods and services actually bought and pro rate according to total value, in order to come up with a single price inflation number. That way, you don’t need to impute anything if it is not available and it will capture the amounts spent on high demand goods but only let it affect the inflation number by the value spent on them.

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