Inflation in the UK falls to 2.4% in June but how long will the improvement last?

Today will bring the latest official inflation numbers for the UK and I wish to discuss the outlook for it. There are various factors which influence the rate of inflation we see. But we find ourselves in a situation where inflation has been above its targeted level of 2% for the Consumer Prices Index for some time now. This has been particularly noticeable because the underlying performance of the UK economy has been so weak over the same period. These two combined events were one of the first themes of this blog and back in late 2009 I was something of an exception in predicting an inflationary episode for the UK. The peak was back last September when CPI reached 5.2% and this measure has been above its target since December 2009.

Paul Krugman does not agree

Some nuance is required here because he mostly writes about the US but last autumn Paul Krugman wrote saying that the UK was not suffering from an inflationary episode. Yesterday he hit on the same theme for the US and here is the title.

On The Curious Persistence Of Inflationary Obsession

Actually there is very little on inflation here apart from Paul’s regular (and rather overused in my opinion) attempt to smear any opposition to him. Those with inflation worries are apparently afraid of.

Zimbabwe-style inflation just around the corner

I notice the use of the word “Obssession” to describe those with inflation concerns which sounds rather like “denier” in the climate change debate to me. I wonder how he would describe his own views! In fact the atmosphere feels rather like the one when those with inflation concerns in the UK were called ” inflation nutters”. By whom? one Mervyn King. You may not if you had read that back in 1997 be entirely surprised by the performance of inflation on his watch!

What are the latest numbers?

The more recent trend for inflation to head nearer to its target was reinforced by today’s numbers.

The Consumer Prices Index (CPI) annual inflation stands at 2.4 per cent in June 2012

The Retail Prices Index (RPI) annual inflation stands at 2.8 per cent in June 2012

If we look into the detail for these numbers we see this.

The largest downward pressures to the change in CPI annual inflation between May and June came from clothing & footwear, transport and food & non-alcoholic beverages

Indeed we have seen actual price falls as well here as the underlying CPI index has fallen for the second month in a row. In April it was 122.9, in May 122.8 and in June 122.3 (2005=100). A similar pattern can be seen for the Retail Price Index or RPI which has gone 242.5,242.4 and then 241.8 over the same period (1987=100). It has been quite a while in the UK since one could write that prices have in fact fallen back.

UK Producer Price Inflation has improved too

The most recent recording for this number has shown an improvement too.

Output price ‘factory gate’ annual inflation for all manufactured products rose 2.3 per cent in the year to June 2012, compared with a rise of 2.9 per cent in the year to May 2012.

Month on month the output price measure for all manufactured products fell 0.4 per cent between May and June.

So we can see that if we look at the production chain the situation is much better than we have become used to seeing and if we peer further down it we see this.

Input price annual inflation fell 2.3 per cent in June 2012, compared with no movement in the year to May 2012.

Month on month, the input price measure of UK manufacturers’ materials and fuels fell 2.2 per cent between May and June.

Yes we are back in yesterday’s land of negative numbers! And we can conclude that the starting point of the UK price chain will continue to help reduce inflationary pressure. Just to give you an idea of what a change this represents then last September annual input price inflation was 18%.

Shouldn’t we be doing better than this?

This is a question of nuance but the UK economy has been performing poorly and if we look at the latest UK inflation report we see that if we measure our economic output at 100 in 2008 it is now just over 95 or as it puts it.

The recovery in output since the 2008/09 recession has been unusually weak, with activity broadly flat since the middle of 2010.

On reviewing that you might be wondering why we have had any inflation at all let alone a sustained and continuing episode of above target inflation. Indeed if we bring 2012 into the equation the economy is actually shrinking with no end to the contraction in sight. The construction sector in particular seems to be in severe difficulty as the numbers quoted below highlight.

Comparing the three months from March to May 2012 with the same three months one year ago (constant (2005) prices, non-seasonally adjusted) we see that:   The volume of construction output decreased by 7.4 per cent. New work decreased by 9.9 per cent and repair and maintenance decreased by 2.4 per cent

And the next part of this report was even more grim. Frankly the numbers below look rather depression type levels.

 Over the period, the volume of new public housing work decreased by 22.9 per cent; new public non-housing (excluding infrastructure) decreased by 21.5 per cent; and new infrastructure decreased by 21.3 per cent

In essence here we are looking at “output gap” theory and my contention has been that it has not worked in the UK. If we return to the Bank of England’s output figures for 2008 and add trend growth of say 2.5% then at the end of 2012 we should have been at 110 rather than 95. Such a large gap should mean that inflation should be not only negative by now but have been there for a while and should have had a sustained period of being below rather than above target. Bang goes that theory I think.

UK Productivity is part of the problem

Using the figures from the Bank of England’s May 2012 inflation we report we see a factor in our current economic malaise. It is productivity or to be more precise the lack of it. Continuing the pre credit crunch era trend would leave UK productivity now at around 117 whereas it is in fact at 100 or firmly at the 2008 base level. Something of a shocker isn’t it? Actually any readers who work in manufacturing can excuse themselves to some extent as it has improved recently to 110 on this scale. But I am afraid that those of us (the vast majority) who work in the service sector look slackers since 2008..

So we see that a poor productivity performance looks as though it has been one of the factors in our inflationary episode and sadly that looks unlikely to turn around any time soon.

The Bank of England continues it inability to forecast anything

Just as we have an improvement in our inflation position the Bank of England abandoned its view that inflation was going to be below target which it had sustained throughout the period when it was in fact well above its target. From the May Inflation Report.

The higher near-term inflation outlook also reflects other pipeline pricing pressures

That effort has turned out to be rather spectacularly inaccurate but there were others.

In the near term, inflation is likely to remain well above the target, a somewhat higher profile than thought likely three months ago

It is a bit like stop-loss positions in markets where human psychology seems to drive people towards taking exactly the wrong views when under high levels of pressure.

Some relief for savers

Last month was the first time that savers in tax-free accounts could make a real return compared to the official level of inflation. This month those in ordinary accounts have a chance as an interest- rate of 3% would be required for this. Not much of a margin but something after a long period of negative real returns.

Comment

So finally we see UK inflation on both its measures head back towards their targeted levels. In itself this is good news and we should welcome it. The undercut to this must be worries about the overall economy and how weak it is.

Also if we consider that inflation has been over target for a while let me give you another concept. That we should aim to put the price level where it would be if it had been on target which would mean that it would need to be below target for a while. Thoughts of an inflation nutter? Not quite as I am simply floating the reverse of an idea put forwards by some when US inflation was below target. What is sauce for the goose etc.

Looking forwards the outlook may not be as good as these numbers may indicate. The oil price is invariably volatile but the price of a barrel of Brent Crude Oil fell below US $90 in June whereas it is now US $104. I can vouch for the fact that in my area the price of petrol and diesel has edged higher in the last week after a period of falls. I would be interested in readers thoughts on what has happened in their area.

And my theme of institutionalised inflation in the UK has received two supporting elements. Firstly we saw that the £9 billion rail infrastructure project was to be mostly paid for out of rail fare rises. And secondly my gas and electricity provider (First Utility) has told me that average prices will rise by 9.5% from the 1st of August via a very complex list of price changes.

So we have a chance of actually hitting our inflation target in the late summer/autumn especially as the rise in petrol duty was delayed. But it may be a brief episode perhaps a bit like the sun in this UK summer.

 

This entry was posted in General Economics, Inflation, Stagflation, UK Inflation Prospects and Issues. Bookmark the permalink.
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  • Miles Saunders-Priem

    I think the real danger is deflation, BOE doesn’t mind if inflation is above 2%, but if it goes below the BOE will promptly counter this. Their agenda it seems is simple: screw savers and anyone holding cash, and force every citizen to either spend their money or invest it in stocks or government bonds. This is bubble-blowing stuff as capital levels go down…

    A thing that puzzles me is high corporate levels of cash; why don’t they spend it if their balance sheets are so apparently strong? If you could answer this conundrum Shawn I will be most grateful.

  • PieterC

    Hi Shaun, I’ve sometimes wondered whether the retail price of petrol/diesel is deliberately altered to manipulate the RPI/CPI indices. On July 3rd I paid 131.9p/litre for diesel at a major Tesco store in Sheffield, the lowest for a long time. Prices have since gone up again. I wonder on what date the data submissions for RPI/CPI formulation are taken ??

  • Anonymous

    Shaun,

    Currently in France fuel prices have increased roughly 5% as holiday season gets underway – Euro weakness not helping. UK energy prices still major multiplier when it comes to inflation so not looking good later in the year? Will GO need the extra fuel tax in Jan 2013?

  • Anonymous

    Hi Shaun,

    EUR:GBP should have a large effect on UK inflation, maybe the 18% input costs inflation reflects increased costs of imported materials etc.  Hence the inflation reduction may be due to the present weakness of EUR, not Mervyn King’s actions.

    We just need to observe how the CHF is performing to demonstrate that the UK is not doing well …

  • Rods

    Hi Shaun,

    Another good piece of analysis.

    I’m sure we are going to get another severe bout of food inflation due the bad UK weather and hot weather and a current drought possibly sending grain yields down in the US. Many UK farmers are complaining that they cannot even get on to their fields with a tractor let alone harvest anything!

    With world grain reserves at a low, due to previous bad harvests in Russia, lets hope Russia and the Ukraine have a good year.

    I think the BOE is targeting growth (not very successfully) rather than inflation, which is why there is more QE and bank liquidity schemes to get the banks to lend more. Without growth the only way the Government is going to eliminate the structural deficit is through more austerity (Government spending growing slightly less) and tax rises. This year I see tax the take will rise from 38% of GDP to 39%, so we are already on an onward march towards 45% to eliminate the deficit.

    How much of the commodity inflation is due to bank speculation and market manipulation, who knows, but all of those QE pounds, will need a home and a market where the banks can turn a profit. With the current crop of bank/market manipulation scandals I’ve no confidence in the correlation between market demand and market price. JP Morgan has already priced 2013 futures for US wheat 40% higher than this year, before US harvest totals are known!

    I think the Olympics have hidden much of the UK construction industry weakness, but now that is finished, the industry will take a bit of a hammering. The Government have cut many capital spending projects, so the outlook is not good. Hopefully, when Government money is saved elsewhere some of this will be used for improving infrastructure and reducing the housing shortage, but I won’t be holding my breath. Charging commuters more and spending that on improving the railways is not going to provide any short term growth, where they are robbing Peter to pay Paul. 

    Petrol prices at my local garage went up from £131.9 to £132.9 last Friday.

    UK economic outlook for the next few years: Stagflation.

  • Drf

    “The more recent trend for inflation to head nearer to its target was reinforced by today’s numbers.”  I have written it before and I write it again, and I am not alone in my viewpoint:  no central bank can engage in ongoing and continuous debasement in a modern democratic economy without this being supported by fake official inflation data, to conceal the real effect which continuous debasement is having, because it is necessary to deceive the majority of the unaware electorate to get away with it. Fake inflation numbers weighted on the price of items which no one buys regularly and which no one needs to survive, and other means of statistical manipulation, is part of the manner of accomplishing that deception. The fact that the majority of professional economists and financial journalists do not expose this and do not even state it the way it is, is part of this process of collective deceit.

    What this announcement today means in reality is that the way is again cleared for the BoE to shortly announce even more permanent debasement of Sterling in the form of QE “to stimulate the economy”!  But the problem of course is that it does not stimulate the economy, as any fool can see clearly by now, particularly those who continue to lose their jobs, but instead it destroys jobs and the destroys the real wealth creating processes, as it has done ever since WWII. 

    There is only one real way to stimulate any economy, as was shown in Hong Kong many years ago, amongst others; reduce taxes and government interference, and thus encourage the economy to grow naturally and exponentially (Laissez-Faire).  That of course also means cutting public expenditure severely, which is what the politicians do not want to do.  So instead they, and it seems most economists, continue the deceit instead! All the real evidence shows that the present course and approach does not work; when are people going to awake?

  • JW

    Hi Shaun
    Productivity is of course at the heart of our problems. Employment in the public sector increased before the expected cut-backs so it could be ‘decreased’ in a managed way. Overall no changes in headcount with depressed activity, hence falls in productivity. Add in the UK trending the same way as US towards a ‘part-time’ economy and you also get reduced net income to spend as well as the ravishes of inflation.
    And the ITEM club think ‘consumers’ will power the UK out of ‘recession’ in the 2nd half of the year. I must get some of that stuff they are using!
    The Depression will stay in place for 5/10 years and that is if we are lucky. 

  • The_forbin_project

     Hello Shaun,

    Eventually  by sheer luck the BoE will get one month where the Creative Price Index will be at or near 2%

    and hear them crow !

    Its a constant amazment that  the other media outlets  are just pushing the party line !

    Can they not see the writing on the wall? 

    As pointed out in below posts – real high street inflation is being baked in though levies  for infrastructure ( we were told that the companies would go to the city for finance…. fat chance ) . and external prices …..

     (all utlilities now will be used a milch cows by their owners , many being  abroad and not caring what the the British public think !)

    after the Olympics come sept/oct  we shall see what the real economy is like…. and I’ll bet it won’t be pretty ! but then again perhaps they’ll get Gok to fashion it up!!

    Forbin

  • Anonymous

    If the government of the day and the BoE conspired in the rigging of Liebor the massaging of CPI / RPI numbers would not surprise !

  • DannyBoy

    Surely this is expected following a dip in oil prices (in both usd and sterling), and unless the mpc also magically controls global supply and/or demand of such commodities then they’ll be hard pressed to take the credit for temporarily meeting their target.

    But isn’t this the core of the problem: that our inflation level is driven by external forces that the UK has less and less control of. That’s why I believe the output gap theory that you continually point at Shaun, doesn’t work- the UK economy cannot be considered to be a closed system. I would hope the boe amend their models in time, but perhaps it is convenient not to at present, for reasons we can only guess at.

    Anyhow, this is all part of us finding our near-term position in the world, which is as a relatively poorer nation. I would imagine we will continue to see higher than target inflation, and below inflation wage increases for at least several years. Result: Stagnation.

  • DannyBoy

    “Result: Stagflation” that should say.

  • Mike

    A good article Shaun – thanks.
    Here also from Mish today is another interesting blog.
    http://globaleconomicanalysis.blogspot.co.uk/2012/07/what-role-does-government-play-in-price.html

  • Anonymous

    Hi Miles and welcome to my part of the blogosphere

    As to your question I would simply put it down to a human emotion fear and a state of mind exhibiting uncertainty. In more basic terms it also implies a lack of trust in the banking system, as in they are afraid they may not be able to borrow if they should need too.

    Doesn’t any animal under stress hoard food?

  • Anonymous

    Hi PieterC

    I can help with that. From this months ONS detailed briefing note.

    “Motor fuels: prices are collected in the middle of the month for the RPI but are averaged across the month for the CPI. This resulted in a larger downward effect on the RPI than the CPI;”

  • Anonymous

    Hi Chris

    The way things are going I think he will have to levy the tax as he is likely to be deperate for revenue. But we do not know what the oil price will be then so it is not absolutely certain.

  • Anonymous

    Hi Rods

    Watching the film Trading Places always made me think of manipulation when I checked “softs” or agricultural futures prices. But it turns out that softs were harshly treated as so many other markets have been manipulated too!

  • Anonymous

    Hi HoppingPot and welcome to my part of the blogosphere.

    The problem for our times seems to be finding out what has not been manipulated and what has. I think before this is over we will discover that the list of the former is considerably longer than the latter….

    In some ways this is an answer to the question posed by the first comment today. Some combination of fear,uncertainty and lack of trust is the answer I think and such behaviour only makes it worse.

  • Noo 2 Economics

    Hi Shaun, an interesting blog today. I think there are positives to hold onto today – that “inflation” has been within tolerance for 2 months now, notwithstanding what has happened to real wages.  Bizarrely, fuel prices have remained unchanged here for a few weeks.

    Rods was hoping for a good grain harvest in Russia this year. I read on “Sober Look” a week or so ago that Russia and China have also been hit by droughts although less severe that the US. I agree with Rods and  am confident of inflation increases  later this year as the crop failures translate into higher foodstuff prices (anything that uses corn or wheat) and as most of this is imported we will be hit by the second part of the double whammy being the weakened pound due to the BOE’s ongoing debasement.

    That’s before we even consider the disaster that is the UK summer with crops rotting in the ground.

    Of course, if the UK continues to (paradoxically in my view) hold on to it’s perceived “safe haven” status the pound may well hold up  despite the BOE’s worst efforts!  

    Dannyboy and you have  hit the nail on the head – I think that currently, most of our inflation comes from external sources (commodity imports)  with one main internal source – Government (fuel duty and QE – yes I know the BOE is supposed to be “independent” – ahem). So whilst we have no control over one we could at least attempt some deflationary measures  with the other.   

    As ever an enlightened blog, I admire your warts and all analysis.    

  • Anonymous

    Hi JW

    “Employment in the public sector increased before the expected cut-backs so it could be ‘decreased’ in a managed way.” I can hear the episode where Sr Humphrey Appleby described this as a tactic as I type a reply to that.

    I agree that the ITEM club forecasts were somewhat bizarre……

  • Anonymous

    Hi Danny

    I think that some on the Monetary Policy Committee actually believe that they are in control of events in some way and can grandly twist knobs and pull levers and the economy will recover. Adam Posen continually gives that impression for example.

    In reality it is sometimes much less pleasant than that and a real central banker in my view has to sometimes take very difficult decisions when events are against you like a sterling fall causing inflation. Instead they have behaved like an Ostrich and we have seen no economic progress at all.

  • Anonymous

    Hi Mike

    If you want an insight into US inflation then the work of John Williams on Shadowstats will give you plenty to think about!