Simmering Gently

21/10/2016 at 5:01 pm

Followers of the UK’s business media will have noticed coverage of an unfamiliar subject this week. On Tuesday we discovered that the annual rate of CPI inflation had rocketed up to 1%. Last week this blog opined that it was actually input prices which would merit close attention; this did not happen so detail on those shortly. First, however, let us deal very quickly with the headline rates.

1% on the CPI is indeed “the highest rate of inflation for nearly two years”. But that is not saying terribly much for two reasons:

  1. Over the longer term 1% is an insignificant number. Before the recent period of energy-driven disinflation CPI hadn’t fallen as low as 1% since September 2002, when the world was still recovering from the collapse of the TMT bubble. Its average over the past 20 years has been 1.9%. Exactly five years ago it peaked at 5.2%. So it ought to be difficult to become too excited by the print on Tuesday (which was broadly in line with expectations anyway).
  2. The “core” CPI measure, which cuts out energy, food, alcohol and tobacco, had already hit a level of +1.5% this March. What we observed this week was the continued closure of the gap between core CPI and the headline rate. In other words, the pickup in headline inflation tells us more about the dwindling influence of cheap oil than it does about, say, the weakness of sterling.

This is not to dismiss the significance of the CPI data entirely. But if we are looking for the fingerprints of the pound we will not find them here.

And so to PPI: producer price inflation.

There has been a little more drama here. Input prices were again up by more than 7% on the prior year – not at quite as high a rate as for August but nonetheless, this measure is showing more heat now than at any other time since 2011. And this time we know sterling has something to do with it since the core measure of input price inflation, which strips out oil among other things, has also reached levels not matched in almost five years. We should expect this to be the case: with the pound down by over 20% on a trade weighted basis in the past year it is a matter of the “basic laws of economics”, as one of the better comment pieces had it this week (it always a pleasure to find that one has friends in common with people).

That piece also carried a forecast from Lord Haskins, former scion and chairman of Northern Foods, that food price inflation in particular is on track to hit about +5% in a year or so. Again, those “basic laws” do tend to repeat themselves. The last time we had a comparable fall in sterling was during the years 2007-8 when the trade weighted index shed nearly 30%. By mid-2008 that input price inflation had peaked not at +7% but at +35%. Back then the food component of the CPI hit a ceiling only at +14.5% making Lord Haskins’ prediction seem quite mild.

Of course in 2008 this didn’t last. The currency found a level and input price inflation fell away again. The domestic economy was contracting, and output would not fully recover until Q3 2013. Unemployment had already started to rise – though it would take three years to reach its peak of 8.5%. And the housing market was in a state of freefall. (It was not until mid-2014 that the average UK price would recover its 2007 high.)

Back to the present.

Should sterling hold its current level the inflationary impact on producer prices will persist, to a greater or lesser extent, into the summer of next year. And nowadays the position of the economy could hardly be more different.

GDP growth of +2.1% is precisely in line with its 20-year average rate and though such estimates are fertile grounds for analytical controversy is likely to be near or at its trend rate. Similarly unemployment of 4.9% could well be regarded as “full employment” and nationwide house price inflation is still running at over 8%.

Given that Britain’s circumstances are so very different today, what is curious is that the policy response to all this is exactly the same as it was in 2008: interest rate cuts and QE from the Bank of England, and if he can get away with it in next month’s Autumn Statement, fiscal largesse from the Chancellor (gilt yields suggest he might be able to fiddle his way to justifying it despite the lousy borrowing numbers out this morning).

Something about this is not quite right. Perhaps the Bank’s expectations that Brexit will see labour market slack and falling output will be met. But even the Bank acknowledges those Basic Laws. And in only a few months’ time, the clear signs of price inflation simmering away at the bottom of the pot could very easily have erupted into a vigorous boil.

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