July 16, 2008 | posted by Michael Baxter in inflation | comments (0) |

And that devilish dilemma got a lot more devilish yesterday.

Inflation is up again. Now the CPI rate is 3.8 per cent. The highest level in 11 years. The retail price index was up to 4.6 per cent, and even core inflation with alcohol, tobacco and food taken out hit 1.6 per cent.

Food and non-alcoholic drinks leapt up by 9.5 per cent, petrol by even more. Now, it is widely expected CPI inflation will hit 4 per cent soon.

And yet. Wages during the same period also rose by 3.8 per cent. Interestingly, wage inflation both with and without bonuses was exactly the same this month.

The last time average earnings with bonuses rose lower than that was August last year. As for earnings before bonuses, they rose at their lowest rate since January.

The point is this. Despite media talk of a winter of discontent building, of strikes as unions spoil it all and demands of inflation-busting wage increases, up to now there is no sign of a secondary inflationary effect from rising wages at all.

Economic productivity is up around 1.7 per cent, so if you take productivity from wage inflation you get the true impact wages must be having on inflation. Right now, that is 2.1 per cent; just 0.1 percentage points off the Bank of England target.

The truth is we are not seeing real inflation at all. We are seeing rising prices. We are all getting worse off. That is not the same thing as inflation, or at least not the same thing as sustained inflation.

If prices rise and wages don’t keep up, we feel worse off. Demand falls. Prices then fall too. This is what is happening now. It will just take time for this to be reflected in the inflation data.

June 19, 2008 | posted by Michael Baxter in inflation | comments (0) |

Well, we are sorry.   The economic debate moved into a new phase yesterday.  Maybe we are now set to go through the most critical period yet in the story of this extraordinary economic crisis.   And it has come down to that old-fashioned issue: pay restraint.   Real income is falling, will we see a wage price spiral?    Following a period of massive inflation in executive pay, trade unions are reasonably asking why their members can not receive pay rises in line with inflation.    It is a mess.

Here is the story in 10 stages.

Stage 1 – On April 25, in this column, we said that painful as it is, we will just have to accept that higher commodity prices mean we are worse off.  Providing we do that, take it on the chin, the rate of interest will stay down, and unemployment should not be affected too badly.  But, if we try and somehow avoid paying the cost of rising commodity prices, through demanding and then getting inflation-busting pay rises, interest rates will go up, unemployment will rise.

Stage 2 – On May 9 we told how, according to KPMG and Recruitment and Employment Confederation (REC), April saw the lowest rate of pay inflation during the last 57 months.

Stage 3 – On June 12 we told that average earnings, including bonuses, rose by 3.8 per cent in the year to April 2008, down from 4.0 per cent in March.    At that time, the retail price index was rising at 4.2 per cent.   Theoretically, providing  wage inflation minus improvement in productivity is no greater than the government’s inflation target, then there is no need for a rise in interest rates.    Economic productivity was up 1.7 per cent in the year.

We also said: “Unions do not the have the muscle they once did. A repeat of the winter of discontent seems unlikely.  There has been plenty of anecdotal evidence to suggest some workers at least are accepting pay cuts.”

Stage 4 – Earlier this week, Shell’s tanker drivers were awarded a 14 per cent pay rise over two years.

Stage 5 – Yesterday (June 18),  the BBC headlined a story suggesting our gas and electricity bills will rise 40 per cent by Christmas.

Stage 6 – In his letter to the chancellor, made publicly available on June 17, the Bank of England governor talked about wage inflation.  “This has been moderate up to now,” he said, but added, “The prospective squeeze on real incomes associated with higher inflation, together with the reduced availability of credit, is likely to lead to a further slowing in activity this year.  This will reduce pressure on the supply of capacity of the economy and dampen increases in prices and wages.”

Stage 7 – Yesterday, Brendan Barber, General Secretary of the TUC  said: “Our economic difficulties are caused by reckless lending by bankers and inflation comes from higher oil, food and commodity prices … Inflation and the pressure on wages will drop as the economy slows. That does not suggest we are heading for a runaway wage-price spiral.”

Dave Prentis, general secretary of Unison said: “Public sector workers have had below-inflation pay deals year-on-year. We are balloting 800,000 local government members for strike action over a 2.45 per cent pay offer and, if inflation continues to spiral, we will trigger the re-opener clause in the NHS deal and go back for more money.”

Dai Hudd, assistant general secretary of Prospect said: “If the fuel tanker drivers’ settlement represents pay restraint in the private sector, can the public sector have a little of that restraint as well?”

Stage 8 – At Prime Minister’s Question time yesterday, Tory MP Sir Michael Spicer  asked: “Why are there so many strikes at the end of a Labour government?”

Stage 9 – In his Mansion House speech, yesterday, Mervyn King said: “This year our real take-home pay will rise at a slower pace than national productivity. Rising fuel, gas, electricity and food prices, mean that average real take-home pay will stagnate this year. It will not be an easy time, and I know that some families will find it particularly difficult. But it is only a temporary slowing in the growth of our real take-home pay, and remember that this is the opposite side of the coin to the falls in prices of manufactured goods from countries such as China and India, which in the nice decade allowed our standard of living to rise at a rate faster than productivity.”

Ominously he also said: “There should be no doubt that the MPC is prepared to take whatever action is needed to return inflation to the 2 per cent target and to keep expectations of inflation in the medium term anchored to the target.”

Stage 10 – Yesterday, the minutes of the latest MPC meeting were revealed, and it emerged they considered upping interest rates.

We have been through a period of almost-obscene rises in pay for people in senior positions.    Incredulously, now MPs want an inflation-busting pay rise.    This has already created resentment.  Now we are being told we have got to accept that over the next year or two we are going to be worse off.  You can’t blame unions wanting to press for higher wages. 

Margaret Thatcher famously described unions as “the enemy within”. On this occasion, it is tempting to conclude the enemy sits higher up the hierarchy.

But, if unions are successful, and wages do rise, the Bank of England will have no choice but to up interest rates, and maybe by quite a bit.  Unemployment will rise, until wage increases stop.   Such a scenario will make a recession inevitable.

June 16, 2008 | posted by Michael Baxter in inflation | comments (0) |

Inflation is back in the public spotlight yet again.   Uncle Sam kicked off the latest round, with news that May saw consumer prices rise by an alarming 0.6 per cent.

But inflation worries are doing the globe.     The Asian Development Bank is making dire warnings about rising prices in Asia, and the G8, meeting in Osaka, and the World Economic Forum too, seem to be wringing their hands over the beast known as inflation.

In the US, the headline figure measuring month-on-month changes in consumer prices rose by 0.6 per cent, compared to an expected 0.5 per cent.  The annual rate of US inflation is now 4.2 per cent.

No prizes for guessing why.  Energy prices shot up by a stunning 4.4 per cent in just the one month.    US food prices rose by a more sedate 0.3 per cent.

Peek beneath the surface though, and strip away food and energy, then the picture is not so bad.  The month-on-month change in consumer prices without food and energy was just 0.2 per cent and the annual rise 2.3 per cent.

Neither is the rise in the headline figure quite so unprecedented.  It was higher in November last year, for example.

The real problem seems to be that it is a worldwide problem now.

Asian Development Bank (ADP) is worried.  Inflation in India has hit a seven-year high; inflation in Vietnam has topped 25 per cent; and across the continent the ADP reckons average inflation will be greater than the 5.1 per cent previously estimated.

Meanwhile, finance ministers at the G8 busily put out a joint communiqué yesterday.  “Elevated commodity prices, especially of oil and food, pose a serious challenge to stable growth worldwide, have serious implications for the most vulnerable and may increase global inflationary pressure,” they said.

There is no doubt that the economies of Asia are facing a serious inflation problem.   But as for the UK, Europe and the US, the jury is out.  There are two points, however, in the story.

The price of oil is shooting up, food too; this is creating inflationary pressures that remind many of the 1970s.

However, wage inflation remains modest; the credit crunch is starving Western economies of cash.    If the monetarist are right, and inflation is always a monetary phenomenon, then a credit crunch is hardly the condition upon which you would expect inflation.

However, we may be paying the price for early noughties excess.     Inflation was low earlier this decade because of cheap imports from China and India.  But, during this time, the money supply ballooned, and spending shot up.

Now we are seeing the flip side.  Demand from India and China is pushing up commodity prices.

You can’t celebrate low inflation caused by external factors for years, then, when inflation picks up, say it doesn’t matter and that it is down to external factors.

June 10, 2008 | posted by Michael Baxter in inflation | comments (0) |

What a dilemma.  Yesterday, we told how some workers are accepting cuts in wages – in the longer-term this could lead to a period of deflation, especially when oil and food prices peak, and then in due course work their way out of the annual inflation data.  But that is a problem for next year, maybe the year after.    Right now, it is the opposite, and more evidence emerged yesterday to suggest inflation is back.

In fact, the latest data from the Office for National Statistics was so bad that economists were being forced to give their Thesaurus a battering, as they reached for the right words.    “Absolutely horrendous,” said Jonathan Loynes at Capital Economics; “Absolutely appalling,” said “Howard Archer at Global Insight; and “Absolute Beginners,” said David Bowie.

It’s producer prices that are bringing such woe.  Non-seasonally adjusted year-on-year input prices rose by a stunning 27.9 per cent in the year to May.   It’s a record.  Even more alarming, if you strip out food and oil, prices were still rising by 14 per cent.

Then there’s manufacturers’ output prices, that is to say, what they charge their customers.    Ouput price inflation hit 8.9 per cent, and even underlying inflation, that’s with food and energy taken out, was 5.9 per cent.

Okay, food and oil will stop rising, eventually, and as we have argued here several times recently, beyond that may well fall.  But news of rising underlying prices is ringing some seriously loud alarm bells.

Capital Economics said: “Admittedly, some of the rise in ‘core’ PPI inflation reflects sharp increases in those elements which are heavily influenced by oil prices, such as chemicals. But other components such as machinery and equipment have also seen prices rising more quickly over recent months.”

It does of course leave the Bank of England with a terrible dilemma.  With bad news seemingly the UK’s biggest import at the moment, British industry needs a rise in the rate of interest like it needs a hole in the head.

And yet, a rise in interest rates is precisely what money markets are factoring in.   In fact, yesterday, the SWAP market for two-year mortgage deals saw its biggest one-day increase since 1992.

Capital Economics says: “The chances of a recession are growing by the day.”   

Yet, with credit so tight, with no evidence wages are seeing inflation-busting rises, the prognosis for inflation in the longer-term still sits in the balance.  The Bank of England runs the risk that by fighting the inflationary pressures that are currently exerting so much pressure, it could be stoking up deflation further down the line.

June 10, 2008 | posted by Michael Baxter in inflation | comments (0) |

The sun put its hat on in May, consumers went out to play, and retailers said hip hip, hooray.

March and April saw the worst year-on-year performance since 2005, said the British Retail Consortium (BRC) this morning, but, in May, UK retail sales values rose 1.9 per cent on a like-for-like basis, compared with May 2007, when sales were up 1.8 per cent.

BRC said: “Some warm sunny days this May compared with very wet weather last May boosted sales growth,” and “food sales strengthened, with clothing seeing year-on-year growth after several months of declines.”

But alas, it wasn’t all good news.  “Underlying trade remained tough, with widespread discounting,” and “furniture and larger homewares remained well down on a year ago, despite continued discounts and promotions,” said BRC.

Stephen Robertson, Director General, British Retail Consortium, said: “After several mostly miserable months, warm sunny weather finally arrived in early May and helped lift customers’ gloom. Significantly clothing sales saw year-on-year growth for the first time since last August, while sales of footwear, outdoor leisure and gardening goods also rose. But we are not out of the woods yet. The economic fundamentals remain weak. BRC/Nielsen consumer confidence figures show the economy is the major concern for a third of people. The housing slowdown and tighter household budgets meant that, despite heavy discounting, furniture sales were well down on a year ago and there was a continued slowdown for electrical goods.”  

Frankly, with house prices in such disarray, it is a miracle that the High Street is bearing up so well.  Some will say this provides more evidence that consumer spending is not influenced by house prices.  But the truth is, the relationship is complex and time lags are involved.   People are complicated, and just because a few months of bad news do not lead to the populace rushing for tranquilisers, it does not mean there is no link between consumer spending and house prices.    

Mind you, the latest news from Alliance Boots would suggest that actually the High Street is in rude health – not that a pharmacy retailer wants us to be in rude health – presumably, it wants us to get a touch of hay fever or some other ailment.

Alliance Boots is owned by private equity these days, and as such is not obliged to tell us anything.  But this morning, it did anyway.

Like-for-like sales rose 1.9 per cent over the last year, revenue jumped by 4.8 per cent and profits soared 20 per cent.

A year ago, it was bought out by ’barbarians at the gate’ Kohlberg Kravis Roberts.  Its chairman Stefano Pessina comes from the Alliance side of the family.  You may recall before the private equity buyout, he was less than flattering about the City, and grew increasingly frustrated by what he considered the City’s short-termist outlook.

When Boots and Alliance UniChem merged, the city gave the whole idea a slating.  At the time, for example, Philip Dorgan, an analyst at brokers Panmure Gordon, was quoted in the Telegraph as saying : “This is an absolutely terrible deal. It doesn’t make sense. Boots needs another 900 shops like a hole in the head. The most important thing is for Boots to sort out its own shops.”
 
Yesterday, Mr Pessina talked about cost savings as the two parts, Alliance and Boots, are merged.  Maybe he was keen to get one over the City he has such low regard for, and this explains why Boots went against the normal private equity way of doing things, and revealed the figures.

This does of course mean it is hard to tell whether the Boots results are evidence that the High Street is still strong, or merely point to a successful merger. 

June 2, 2008 | posted by Michael Baxter in inflation | comments (2) |

That Ben Bernanke knows a thing or two about depressions.  If there is anyone alive today who has studied the US economic depression of the 1930s more than the current chairman of the US Federal Reserve, then it would be a surprise.

That is why many have been saying we will never see a repeat of that saga, nor will we see a repeat of the lost decade suffered in Japan, not while Ben is in charge anyway.

There is one snag with that argument – not all downturns are the same.  The 1930s, and Japan’s lost decade, saw a crash in asset prices followed by deflation.  And Mr B has been doing his best to ensure those characteristics are not repeated here.

But, and this is the danger, supposing it is not like that.  Supposing the real threat is a return of 1970s style inflation, combined with sluggish growth – stagflation.   The danger has to be that Ben, by slashing interest rates, is making things much worse.

Think of it this way.  Imagine the economy is like a shower.  A shower in which the water supply only responds slowly to a turn on the tap.  So, one moment it is too cold, you turn up the hot tap, but it is still too cold.  What do you do?  Wait a little longer to see what happens, or turn up the hot tap some more?

The danger is that Ben Bernanke has turned up the hot tap before his previous tweakings had been given sufficient time to work. The result – well, very shortly scolding water might come flooding out.

But the analogy ends there. The economy is not like a shower – you can’t turn the inflation and growth taps on and off  like that.  Inflation doesn’t come pouring out one moment, and reduce to a trickle the next.  Instead, it has been likened to a tube of toothpaste.  Stopping inflation is the equivalent of squeezing toothpaste back into its tube.

It is an important point, because right now is a crucial moment.   It is possible that inflation is being allowed to build, and that down the line it will come gushing out – across the world.  The signs are certainly there to suggest this may happen.

Alternatively,  if you believe oil and food prices are displaying all the hallmarks of a bubble, which will burst, sending prices spiralling down, we may re-discover deflation, after all.   In which case Ben will seem like a genius – and may go down in history as the Fed’s best chairman to date.

Which scenario is right? In today’s issue we take a look at both sides of the debate. And to start with, let’s take a look at oil. Which way next for the black stuff – read the next article.

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

It was around 15 months ago when the Bank of England governor put pen to paper and wrote his infamous letter to the then chancellor, a certain Mr Brown, to explain why inflation had hit 3.1 per cent, more than a full percentage point above the 2 per cent target.  At the time, the governor was left with egg on his face, and everybody expected interest rates to go up.

This morning, the latest inflation data was out, and this time we went within a whisker of letter writing territory again.     Inflation hit 3 per cent, and it seems odds on that it will rise again soon, eliciting another letter.

In fact, Mr King must hope he has plenty of ink, because now many are saying inflation will stay more than a full percentage point above target for at least the next three months, which will in turn force another letter.

But it is not just the CPI which is up. The retail price index soared to 4.2 per cent, from 3.8 per cent last month, but, more, to the point, underlying inflation, that is with food, energy and tobacco taken out, was up from 1.2 to 1.4 per cent.

We all know prices are going up – the tabloids are full of it at the moment, and regular readers of this publication should not be surprised. The writing has been on the wall, or perhaps more accurately in the Office for National Statistics producer prices indices, for some time.

Talking of which, yesterday revealed the latest instalment in the story of producer prices. And once again, the pace is up.

Manufacturers saw prices rise by an alarming 23.3 per cent in the year to April.  As Capital Economics said yesterday, the figures were “nothing short of terrible.”

Manufacturers are in part swallowing their rising costs – but not entirely.  Manufacturers’ output prices rose by 7.5 per cent in the year to April, the highest level since the ONS started publishing these figures in 1987.

So inflation is taking hold. Stagflation is back? Well not necessarily.

As we have said before, the Bank of England can get away with cutting rates providing wages don’t go up in unison with prices. 

This does mean, however, that we have got to take the price rises on the chin.    If we don’t, and expect wages to rise so that we are no worse off, then the Bank of England will be forced to increases rates rapidly.

This is good news for interest rates, and good news, perhaps, for the longer-term, but it is not good for our purses and wallets.  

We have got to sit this one out.  The price of food and oil has got to fall, eventually.  Price is down to demand and supply, and at current prices, demand will plummet. Supply will probably rise too as more resources are put into food production and investment into exploiting alternatives to oil which do not come out of food yields benefits.

The problems we are seeing now have been on the cards for a long time.

The real failure has been a lack of willingness to deal with them.    Now we have no choice.