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.
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.