October 13, 2008 | posted by Michael Baxter in inflation | comments (0) |

At last, the hint of good news we have been waiting for. Pipeline inflationary pressures seem to be seeing sharp falls. This is good news; first, because it will make it easier for central banks to justify rate cuts, but also because the falls may prove to be so significant that they may even go negative, thus helping consumer affordability, and, for companies, driving up profits.

According to the latest data from the ONS, input prices, that’s what producers have to pay for the products they buy, fell by 1.2 per cent in September. It is the third month in a row which has seen monthly falls. On an annual basis, input price inflation is still high – 2.4 per cent – but then again it has fallen enormously, from 3.4 per cent two months ago.

Even more encouragingly, output prices, that’s what producers charge their customers, also fell in the month – down 0.1 per cent.

The annual rate of output price inflation is now down to 5.4 per cent, from 6.3 per cent two months earlier.

For the last two years or so, producers have been swallowing most of their input prices, thus reducing the overall inflationary effect, but at the same time eating into profits. As the trend goes into reverse, the boot is likely to be on the other foot, and output price drops will lag behind input price falls, as companies try to rebuild margins.

Even so, it seems output inflation is set to enter a period of sharp falls – don’t be surprised if the annual rate goes negative next year.

October 3, 2008 | posted by Michael Baxter in inflation | comments (0) |

Isn’t it annoying when people say  “I told you so.”  Well,  suddenly it appears that deflation is getting people spooked.  Deflation was that thing that occurred in the 1930s and in Japan during its lost decade.  It is when prices keep falling,  and consumers choose to hold back their purchases, waiting for prices to drop further.  It’s a scenario that any would be first time property buyer (FTB,)  even that rare species,  a would be FTB loaded with cash,  will understand.  Why buy a house now if you expect the price to drop next week ?

The snag is,  when consumers expect prices to drop,  and curb back on their expenditure, the result is less aggregate demand out there.  This leads to job losses,  and then it all gets rather unpleasant.

Deflation is a nasty one.  And it is what you often get when banks collapse. And all of a sudden newspaper land,  and economic think tanks have woken up to danger.

Oh,  and by the way,  we told you so.

Yesterday’s Telegraph headlined  “Financial crisis: deflation is public enemy number one.”

This time, it is a report from the Bank of England that has raised the deflation alarm.

In its latest credit conditions survey released yesterday,  The Bank of England revealed three rather worrisome findings.  First of all, 39 per cent of lenders said they had seen a fall in credit supply over the last three months.  Meanwhile,  demand for secured lending has fallen by 69 per cent over the last three months.  But,  worst of all,  it appears lending to the corporate sector has plummeted 36.2 per cent.

The point is,  three months ago,  things were supposed to be awful.  Yet, there were lots of comments, especially from those companies that produce regular reports on the property market,  saying things were easing.  Well,  now we know.  They got worse.

The Bank of England survey relates to the period 26th August to 17 September,  or,  to put it another way,  most of the extraordinary events we have seen lately,  occurred after this period.  So,  expect lending to have fallen even more in the weeks following the period the survey relates too.

There is a real concern,  that central banks have been too pre-occupied with inflation.  The European Central Bank chose to keeps rates on hold  again yesterday.  But the truth is, the rising inflation we have seen recently was down to factors that occurred some time ago.  The soaring price of oil,  for example,  was down to a delayed reaction from the global economic boom created by rock bottom interest rates,  a credit boom,  and an unprecedented debt bubble.

That is over now.  Crashing asset prices and the crunch on credit,  which has now hit phase 2,  with the banking disaster,  means less money will be spent,  and this will mean lower prices.

Those who believe the key to running an economy successfully lies with the money supply,  argue that the true cause of the 1930s depression was lack of money,  caused by the banking collapse.  By contrast,  Keynesian’s believe the problem was lack of demand. So in a times like these,  monetarists would argue for boosting the money supply - perhaps by buying toxic waste off banks.  Keynesians would argue for tax cuts aimed at the poor,  and increases in government expenditure.

What is clear, is that the rate of interest needs to be slashed.  In Japan it was left too late, and policy makers discovered, to their horror,  that once interest rates had been cut to zero per cent,  there was nothing left to do.

September 23, 2008 | posted by Michael Baxter in inflation | comments (0) |

One of the strange characteristics of this economic crisis is the conflicting forces at work on prices. The are good reasons to fear inflation. It is already too high, and with the extreme measures being taken in the US to put life back into the economy, there are plenty of reasons to fear inflation could escalate.

Yet, equally, deflation is a worry too.

Yesterday, Sir John Gieve, Deputy Governor at the Bank of England, put his pennyworth into the debate.

He warned of the challenge of “balancing that upside risk to inflation from the commodity price shock against a downside risk that the credit crisis would drive down activity too far and push inflation below target in the medium term.”

He said: “The biggest risk to the financial sector is also the biggest downside risk to the economy: namely that damage to bank balance sheets would lead to tighter credit conditions, lower asset prices, lower consumption and investment, and to a severe feedback loop into more losses for banks and so on down a spiral. That feedback is already working to some degree, not just in the US but in the UK too.”

There are the reasons to fear deflation. In the past, periods of deflation have coincided with crashes in asset prices; for example, 1930s US, and Japan’s lost decade. Right now, we are witnessing a crash in both house prices and equities. Don’t forget, both the Dow and FTSE 100 are lower today than at their dotcom peak. An equity bubble in China has also well and truly burst, while the Russian stock market is in crisis.

Deflation can also occur if there is a shortage of credit. When someone borrows money and then goes out and spends it, the money spent is received by someone else, who in turn goes out and spends, and so on. The supply of credit determines the amount of money being spent. This can create inflation. The credit crunch means the opposite of that; credit is, well, crunched.

On the other hand, the recent steps taken by the US treasury to bail out the economy could lead to inflation down the line. It has been suggested that US borrowing this year could top $1 trillion. It was argued above that UK public debt is set to balloon.

Economics text books all agree, when government borrowing surges, inflation often follows.

The truth is, deflation at a time of enormous household debt and rising government debt would be disastrous. Sure, deflation may mean low interest rates, but the real cost of debt would effectively rise. Imagine your debt was the equivalent of half of your salary, and over a period of five years you repaid interest only on the debt, and your salary halved. All of a sudden, your debt would equal your salary.

For that reason, deflation is something that must be avoided.

Quite frankly, it seems the most likely consequence of the Paulson new deal will be that the forces of inflation and deflation cancel each other out.

September 18, 2008 | posted by Michael Baxter in inflation | comments (0) |

For so long inflation seemed to be the most important economic topic. Now it is off the front pages, and yet the last few days have seen two very important developments on the inflation front.

In the UK, CPI inflation has now reached 4.7 per cent. Remember, the Bank of England’s target is 2 per cent.

Electricity prices rose 18 per cent year on year, gas inflation soared to 27.7 per cent, and food prices were up 14.5 per cent – which according to the ONS is a record.

And with that, Mervyn King put pen to paper and did another of his Dear Chancellor letters.

Letters from Merv to Al or Gordon are usually big news; not this time, it barely got a mention.

Meanwhile, in the US inflation fell. Okay, it didn’t fall by much, dropping from 5.6 to 5.4 per cent.

But then consider these words from Capital Economics: “[US] consumer price inflation is set to plummet over the next twelve months and could be down to less than 1.0% by mid-2009.”

In his letter, Mervyn blamed world agricultural products which he said were up 40 per cent, oil, up 60 per cent and wholesale gas prices, up 90 per cent. He warned the inflation peak is likely to be even greater than the level he previously predicted when he last wrote to his boss, back in June. He now expects inflation to peak at 5 per cent.

But, Mr King insists that the action of the MPC will ensure inflation will be back to target soon.

The truth is, however, that inflation is likely to go negative.

Deflation is often preceded by falling asset prices. Inflation occurs when the money supply expands too fast. But isn’t a shortage of money – or at least credit – the problem right now? It seems unlikely inflationary pressures will continue – it seems far more likely inflation will turn negative.

The traditional response to falling inflation is cutting interest rates. But the underlying problem behind this crisis is too much debt. If the Bank of England tries to stop deflation by encouraging us all to borrow, then this could be a very bad move. That is the dilemma the Bank of England will face next.

The solution is not easy to find, but maybe the underlying problem is that in the West the money supply is expanded through debt. The rate of interest falls, the demand for debt rises, this leads to an expansion in the money supply.

Maybe it is time the government took to its helicopter and threw money out of the window – and maybe the best location for this money is our tax bill.

September 12, 2008 | posted by Michael Baxter in inflation | comments (0) |

The latest survey from the Bank of England has inflation expectations among the public up again. But just because that’s what we think, it doesn’t mean it will come to pass. Crowds can get it wrong.

The audience nearly always gets it right. In that TV programme ‘Who wants to be a millionaire’ the audience is invariably right. You can understand why; if only 5 per cent of those in the studio know the right answer, and the rest have no idea, then the voting pattern should favour the right answer. The only time when this doesn’t apply is when it is one of those questions when the answer is different from what you would expect, or when hardly anyone knows the right answer.

So crowds can have a certain amount of wisdom.

But they don’t always get it right. Crowds can be mad too.

We are, alas, all too easily influenced by others. Patty Hearst became a convert to the cause of her kidnappers; we are all rather inclined to swim with the latest tide of irrational exuberance, even if that tide is really taking the economy hostage.

So when dotcoms boomed, not many said this has gone too far. In part, of course, this was because the Internet was really a good idea – people; people instinctively understood this. It is just that in the late 1990s, the wrong type of business plans were gaining traction.

Crowds can get it wrong. That’s why countries can get involved in wars that are doomed to end in failure, and yet the government secures popular support.

The madness of crowds was surely behind the recent property boom.

Then there’s inflation. According to the latest Bank of England survey, most of us think inflation is higher than it really is. Asked to give the current rate of inflation, respondents gave a median answer of 5.4 per cent, a series high and compared with 4.9 per cent in May 2008, the previous series high.

Median expectations are for inflation to hit 4.4 per cent over the coming year.

When projecting inflation, what the public think is important. If the public think it is higher than it really is, and expect prices to rise, they are more likely to go out and spend sooner rather than later, before prices go up. This in turn increases demand, and pushes prices up: expectations can cause to happen the very thing that was expected.

High inflation expectations can also push up demand for wage increases – which can also create inflation.

But that does not mean it will be like that this time. People may think prices will go up, but they are not going out and spending all the quicker, because they can’t afford to.

Public sector workers may be restless, but most of us dare not demand big wage increases – the job market is too fragile. In that environment, public sector workers demanding pay rises are less likely to garner much support from the Great British Public.

The Bank of England survey also found that by a margin of 76 per cent to 3 per cent, survey respondents believed that the economy would end up weaker rather than stronger if prices started to rise faster. This margin was the widest since the survey began in November 1999. So, unlike in the 1970s when we suffered from the winter of discontent, there is a realization that inflation is bad, that it must be beaten, and those who press for wage rises may well find themselves swimming against the tide of opinion.

The public may think inflation is higher than it is, and may expect inflation to be around 4.4 per cent over the year, but that doesn’t mean they are right. Crowds can get it wrong.

The public see the battle against inflation as one that must be won – sometimes crowds get it right.

September 9, 2008 | posted by Michael Baxter in inflation | comments (0) |

Producer prices fell in August. Both output and input price indexes measuring month on month changes went negative in the month just gone. It was the first time the month on month output index has been negative since October 2006.

So, at last, it seems inflation may be turning.

The annual rate of inflation is still too high of course, it will take some time before that goes negative. The year on year change in the input prices incurred by manufacturers fell to 26 per cent in August, from 29.3 per cent in July. As for output prices, the annual rate fell to 9.7 per cent from 10.2 per cent.

Manufacturers saw the price they pay suppliers fall in no less than six of the nine main categories in August. Crude oil was down 11 per cent in the month, but then fuel, home food materials, imported food materials, imported metals and other import materials all fell in cost. Even in the areas where input costs did rise, the jump was quite modest.

The falling price of oil was the main factor behind the improving output index. Over the last 12 months, the price manufacturers have been charging for petroleum products has increased by 28.9 per cent. Yet in August, these same products fell by 4.8 per cent. The item which saw the second highest rate of inflation within the output index, chemical products, however, still rose quite sharply – up by 0.9 per cent in the month.

It is just the first step. We will need to see a couple more data releases like this one from the ONS in October and November, before the change in inflationary pressures becomes obvious.

But it does seem we are seeing the positive consequences of the credit crunch. As has been argued here before, the shortage of credit will mean falling demand, which will lead to falling prices eventually. It has been said here that it is just a matter of time before this starts to happen, and this morning’s data shows that time is at last drawing nigh.

September 4, 2008 | posted by Michael Baxter in inflation | comments (0) |

Could that nasty period of food inflation be nearing its end? The latest data from the British Retail Consortium (BRC) out yesterday suggests it may.

According to the BRC, food prices rose by 0.3 per cent on last month. Okay, that’s about 0.3 per cent too high, but then again, in July food prices shot up by 1.9 per cent on the month before.

Now one month’s worth of data does not make a trend, and indeed the monthly figures were even lower than that on one occasion this year – in March, when food inflation was zero. But it is an encouraging sign, nevertheless.

Non-food, inflation, however, picked up in the month – rising to 0.6 per cent in July, after July saw non-food prices drop by 0.8 per cent.

The annual figures are not so encouraging – in fact, food inflation hit 10 per cent year on year in August. The highest level recorded so far during this cycle.

With food prices rising by around three times the rate of wage increases – it is no wonder we are feeling the pinch. But it is the month on month figures that give us the real clue about the future. So it will be interesting to see how this index develops over the next few months.

And that brings us to a first prediction on when the UK economic recovery can begin – to find out more, read the next article.

September 3, 2008 | posted by Michael Baxter in inflation | comments (0) |

Well, actually, inflation in the UK has not peaked yet. Utility bills are still rising, and it seems the consumer price index may well hit 5 per cent within a few months – expect some nasty headlines when that happens. But, looking beyond that, it seems there are reasons to believe the index will then fall sharply.

Consider the price of oil. You remember what it was like earlier this year and last. The price of oil soared on the thinnest of rumours. You would have thought that earlier this week, as Gustav wailed its way inexorably towards the US, the black stuff would have risen in price.

You would have thought that, as the world’s second largest exporter of oil – that would be Russia – plays soldiers, and gives its tanks a good airing, and Vlad recalls the good old days when he was in the KGB, the price of oil would rocket. But, it didn’t.

Then, as that mother of a storm that was Gustav turned into something of a less-fiery Aunt, oil fell. All of a sudden, they are talking about $100 a barrel again.

As ever, there are plenty of reasons to fear this could change. Iran is trying to persuade fellow OPEC members to cut oil supply. Yet normally, even the whiff of a rumour about Iran and Venezuela working together would have sent oil soaring again.

It has been argued here many times before, at current levels oil is not affordable. Should it stay at the current price for an extended timeframe, the global economy will hit recession – and that will hit OPEC. If markets are left to their own devices, and political interference is kept to a minimum, oil will fall rapidly next year.

It is also very much in OPEC’s interests to see oil fall in price – although, in the longer-term maybe not in our interests. The longer oil stays at current levels, the sooner the West will develop alternatives. Solar and wind power may represent the potential for cheap energy for ever, they may represent the solution to global warming, but they would be bad news for OPEC.

So there are two reasons to expect oil to fall in price. Firstly, the credit crunch is causing demand to fall. Secondly, OPEC would be shooting itself in the foot if it tried to stop the fall.

But it is not just oil which is falling; wholesale gas, wholesale electricity and agricultural commodity prices have all fallen recently. Recently, the CBI produced data to suggest the core output price inflation is set to fall.

It will take time. It is like moving a massive ship – there is an extended time lag between a change in the factors that determine course, and the actual change in course. Let’s just hope that the UK can see a change in direction before it hits an iceberg.

August 12, 2008 | posted by Michael Baxter in inflation | comments (0) |

And so inflation hits 4.4 per cent, or 5 per cent if you would prefer to use the older retail price index measure. Furthermore, it seems inflation will continue to rise for some time, with a growing expectation that the CPI index could pass 5 per cent. If inflation measured by the consumer price index is more than 1 full percentage point above the 2 per cent target, then the Bank of England governor does of course have to write a letter to the chancellor. Well, now it looks as if the CPI index could actually rise by more than 2 full percentage points above inflation.

Food inflation is up to a truly worrisome 12.3 per cent, with meat prices up 16.3 per cent, breads and cereals up 15.9 per cent and vegetables, including potatoes, up to 11.1 per cent from a year ago.

The average price of petrol at the pumps increased by 1.2 pence per litre between June and July this year, to stand at 118.8 pence, and air passenger transport costs rose by 8.9 per cent, from just 5.4 per cent a year earlier. The good news on gas and electricity: bills were unchanged this year, but they fell a year ago, so they too contributed towards the bottom line.

To really rub salt into the wound, the increase in inflation from 3.8 per cent in June to July’s 4.4 per cent was the highest change since records began in 1997.

The news from the pipeline is not good either. Yesterday saw the latest revelation of producer prices, and both input and output prices are still way too high at 30.1 and 10.2 per cent respectively and on a non seasonally adjusted basis.

But, at least the input price index fell slightly on the month before – although only very slightly.

But remember this, annual inflation is determined by what goes on over the course of that year. When oil and food stop rising in price, it will take a year for this effect to be fully reflected in the figures, but when it is reflected, the result will be sharp falls indeed. And if food and oil prices continue to fall, as they have been doing over the last couple of weeks, CPI may even go negative.

Prices only go up in the long-term if there is sufficient excess money slopping around the system. Thanks to the credit crunch, fears about job security, and the squeeze on our discretionary disposable income, there is no spare money.

That is why it is likely the current inflationary spiral could turn to deflation.