Inflation presents a contractionary danger for the UK economy yet again

Today is one which us likely to have provoked a smile from the outgoing Governor of the Bank of England Mervyn King and something of a frown from the new incumbent Mark Carney. Whilst Governor Carney’s inheritance has generally been benign as illustrated by last week’s report from the National Institute for Economic and Social Research last week.

Our monthly estimates of GDP suggest that output grew by 0.6 per cent in the three months ending in June after growth of 0.6 per cent in the three months ending in May 2013. These estimates suggest that economic growth accelerated from 0.3 per cent per quarter in 2013Q1 to 0.6 per cent in 2013Q2, largely due to the performance of the private service sector.

Unfortunately for Governor Carney his worry is based on the performance of UK inflation and in particular on the exact numbers for June. This is because is we go back to June 2012 the level of the Consumer Price Index actually fell by 0.4% and so it was always likely to rise this month meaning that his first month would see a rise in inflation. Actually even unchanged prices on the month would have seen inflation rise to 3.1% which would trigger this.

If the target is missed by more than 1 percentage point on either side – i.e. if the annual rate of CPI inflation is more than 3% or less than 1% – the Governor of the Bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the Bank proposes to do to ensure inflation comes back to the target.

At least in spirit Mark Carney’s response should this eventually happen  might like to invoke Shaggy’s biggest hit.

It wasn’t me

Although in a change in remit he does get more time – the figures are released 24 hours earlier to a select list – than in the past which may help too.

If inflation moves away from the target by more than 1 percentage point in either direction, I shall expect you to send an open letter to me, alongside the minutes of the Monetary Policy Committee meeting that followed the publication of the CPI data and referring as necessary to the Bank’s latest Inflation Report and forecasts.

Perhaps even the Chancellor of the Exchequer had become frustrated by and weary of Mervyn King’s efforts in this regard.

Given this, any future open letters should result in a more meaningful exchange between us about the Committee’s strategy than has been possible before now.

Today’s numbers

As it happens an audible sigh of relief might have been heard yesterday morning when Mark Carney received the numbers as they told him this.

The Consumer Prices Index (CPI) grew by 2.9% in the year to June 2013, up from 2.7% in May.

So he escapes for a month at least because prices fell again in June overall with falls (air transport being the largest) more than offsetting rises in motor fuels and and clothing. Indeed the falls in airfares were apparently substantial.

Air fares fell by 2.8% on the month this year compared with a rise of 7.4% in 2012.

If only that were true of my flight to Milan and back! But that was in July…

The Retail Price Index fell on the month too and inflation as measured by it is now running at an annual rate of 3.3%.

The outlook for inflation

Even the Bank of England has finally admitted that there is an ongoing problem here. From the May 2013 Inflation Report.

CPI inflation remains above the 2% target and is set to edge higher over coming months. Inflation is likely to stay above the target for much of the next two years, bolstered by external price pressures and administered and regulated prices.

So the targeted measure of inflation has exceeded its target since December 2009 and even the Bank of England does not think that there is likely to be a change in this situation anytime soon. Instead it is making “administered and regulated prices” something of a scapegoat conveniently forgetting that they have been a feature of UK economic life for years if not decades.

Producer Price Inflation

If we look further down the UK inflation chain we see that the situation is bubbling under again.

In the year to June the output price index for goods produced by UK manufacturers (factory gate prices) rose 2.0%, compared with a rise of 1.2% in the year to May

So whilst this is below headline inflation there is a worrying surge on the month. Also it was driven by what I consider to be the ”core” items of food and fuel, which distinguishes me from many other economists who are apparently able to live without them! Looking further down the chain we see that this looks likely to continue and maybe even increase.

In the year to June the overall price of materials and fuels bought by UK manufacturers for processing, known as total input prices, rose 4.2%, compared with a rise of 1.8% in the year to May.

The rise in June in input prices was driven by Home Food Materials (who makes these categories up?) which soared by 7.2%. As we had not had the recent hot weather by then that leaves the wet weather of 2012 and early in 2013 to take the blame.

But on a more fundamental point if you feel that food purchases have become noticeably more expensive then at least one component of the UK inflation measuring system is agreeing with you as Home Food Materials annual inflation is now running at 14.3%.

As an aside the fall in precious metals has had an impact too but in the other direction.

The index for imported metals fell 1.7% between May and June and fell 4.0% in the year to June. The monthly decrease was mainly due to imported platinum and silver prices.

Apparently gas prices fell by 4.9% in June. I wish mine had! They have been going regularly in the opposite direction.

Looking further afield

The oil price has been on a rising trend recently and a barrel of Brent Crude is now priced at over US $109 and is up just under 6% on a year ago. This presents a quite different picture to when it dipped into the high-90s in early April. Also its rise is being exacerbated by the fact that the pound sterling seems to have entered a weaker phase again and at US $1.505 as I type this is down just under 4% on a year ago. Add the two together and we have the beginnings of some oil price pressure on the UK economy.

Energy Price Pressure

If we look forwards to future years it is also true that it is government policy to raise domestic energy prices. This is of course in stark contrasts to their denials reminding me of “Never believe anything until it is officially denied” one more time.

NPower has weighed into the debate today with this.

By 2020, the relative influence of Government policy and regulation costs on energy will have increased by almost 340%. These policy and regulation costs are predominantly increased charges on the electricity bill rather than the gas bill.

That is particularly unfortunate for those whose domestic fuel bills are for an all-electric property. In case you were wondering the actual effect on an average bill is expected to rise from £185 this year to £329 in 2020.

This is a complicated subject but for now if we stick to today’s subject we remain under inflationary pressure via this route.

Does Inflation Matter?

Many economists are to be found somewhere between ‘it does not matter’ to ‘it is of minor importance’. However let me give you an area where it clearly has been a contractionary influence on the UK economy.

Real Wages

These continue to fall and the new inflation (CPI) numbers mean that if we adjust wages for them they are now falling at an annual rate of 1.6%. For those who feel that the Retail Price Index is more realistic then real wages are falling at an annual rate of 2%.

How likely is it that people will spend more when not only their level of real wages is falling but that it has fallen by 8% so far in the credit crunch era?

Comment

The UK economy remains one which cannot shake off the problems caused by its episode of above target inflation. Worryingly there are currently signs as I have discussed today that problems may be building again on that front. If we look to the latest official fuel price numbers released earlier the price of a litre of unleaded petrol is now 134.9 pence. Not only is this 1.2 pence up on the previous weekly report but it is now higher than the number in the June inflation report.

So Mark Carney may not have escaped writing an explanatory letter to the Chancellor for now at least but more importantly the UK is in danger of an economic boost leaking into inflation one more time. It is as if we have that locked on repeat on our economic I-Pad.

First Time Buyers

I also remain troubled by the way that Help to Buy is inflating prices in our housing market one more time. It is often badged as helping first time buyers but how does the statement below help them?

In May 2013, prices paid by first-time buyers were 4.1% higher on average than in May 2012. For owner-occupiers (existing owners) prices increased by 2.5% for the same period.

Is that a bubble I see? It all seems worryingly familiar and evokes echoes of how we got into this mess….

 

 

 

 

This entry was posted in Bank of England, General Economics, Inflation, Quantitative Easing and Extraordinary Monetary Measures, Stagflation, UK Inflation Prospects and Issues and tagged , , , . Bookmark the permalink.
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  • Drf

    Hi Shaun,

    “Is that a bubble I see? It all seems worryingly familiar and evokes echoes of how we got into this mess….” Yes the newer completely dumb leaders we have are about to do it all over again, but this time it will not be so easy to conceal and to escape from!

  • Anonymous

    Shaun,
    Surely the adminstered & regulated prices are subject to HMG influence by definition?
    As discussed many times energy price inflation has a multiplier effect on the UK economy so I conclude HMG is still aiming for 3+% inflation as part of misguided attempt to inflate away the deficit/debt.

    Massaged cheap energy prices in US will leave UK at a major disadvantage maybe German engineering will come to our rescue as they grapple with phasing out nuclear energy for green alternatives?
    Fuel poverty imposed as an attempt to avoid power cuts perhaps or am I too cynical?

  • Anonymous

    It has been rather obvious for a long time that UK governments never confront their economic problems, they just shunt them forward in time. Over 15 years, you can correct quite a lot of mistakes from the past, though at the expense of current prosperity. Every time I look at this, I am reminded of the decline and fall of a certain empire!

  • MickC

    Stagflation………the 70s revival just rolls on!

  • Anonymous

    Hi Chris,

    The Germans are making serious attempts at well insulated housing – house insulation makes sense because you recoup your investment in lower heating bills. However their “green electricity” subsidies causes financial loss, rewards substandard generating technology and fails to deal with the electricity storage problem.

    The current energy transformation cannot work – substantial changes are needed to prevent it’s failure.

  • forbin

    one little ray of sunshine is that the higher oil price will allow us to develop those little North Sea oil fields

    so some more income for Gov. – now if only we didn’t use so much …..ah I see we’re not – AA reported this year 20% drop in sales since 2007 ( ok thats a peak year) and in “real terms” the Gov’s own figures show we’re back to 1997 for petrol prices ( albeit that 1999 was the peak price year) . Although I note nothing said about dropping real wages and the affordability ……. hmmm , why not?

    loss of tax revenues means road pricing will be used at some point , soon I expect . Although it will not save us from massive tax increases to cover the budget hole.

    As for electricity , I wonder who’s the nut job in charge of these increases? lets fix another institutionalized inflation busting increase , along with rail fares ,etc, etc into the equation…….(sighs)

    but be happy!! you be paying more for your houses , oops sorry , you can borrow more against them …….

    Houses really really should be top of the anti inflation targets – but it wont because its the majick ingredient for the UK economy – complete madness ! Cameroons doing his Nelson impression , ” I see no bubbles here!! ”

    Forbin

  • forbin

    passiv haus standards – bit late but would be welcome. our policies though are always disjointed and tax centric !

    i note that Germany when it does have a surplus of “green ” electricity does not seem to be able to make money on it – indeed the rates go ” negative ” !!

    imagine that QE 375Billion used for passivhaus insulation and ground heat pumps ,

    I see nothing of value since we’ve spent it on propping up the banks – its apparent they’re still bust….and still no prosecutions …. but good news – they’ve squeezed 4.1% more from new buyers – good jobe we don’t count that in inflation figures !!

    Forbin

  • Anonymous

    Hi Forbin,

    A thermal power station creates about 35% electric from heat. The ground source heat pump moves about 300% heat energy relative to the electric energy used in the pump. 0.35 * 3 = 1.05

    Seems easier just to burn the gas in the boiler to heat your house without needing a gas fired power station, a grid and an expensive ground heat exchanger …

    Also I’d note that ground source heat pumps need either lots of land to spread horizontally or a very deep bore hole – both cause problems in our densely populated cities. They do make more sense in rural areas without mains gas.

  • forbin

    Hi ExpatinBG,

    yes looked through the coal fired station driven heat pump and its no so rosy , even the 45% efficient stations being built on account for 50% of new builds ( IEA) .

    Gas fired that makes up our other 40-45% generation ( we use about 40/40 mix of coal and gas generation ) can achieve 50% as well.

    0.50*3=1.50 and yes thats a best figure

    ofcourse proponents of the technology suggest using Solar PV , and ofcourse via HVAC over the continent , either USA or Europe hmm, that will cost .

    With Solar its an issue that no economical storage solution exists – or Germany would be using it ( maybe , then they could sell the surplus for profit . not happening far as I can see).

    Still the issue is that I see no real discussions in the Gov. about what to do …… other than tax it !

    Forbin,

  • Anonymous

    Sean – great post.

    The language used by the BoE is the same as ever: “bolstered by external price pressures”. I love the reversal of cause and effect. We run a deficit and have to have QE to pay for it, so we print, GBP falls and because we are a massive net importer input costs go up. Then the BoE turns around and calls this “external pressures”! It’s maddening how the BBC and co all swallow this without question. Have they not heard of root cause analysis?

    The BoE, IMHO, know exactly what they are doing here. It’s called a soft-default. All they have to do is act surprised for 120 months in a row and the job is done. Who’d have thought they’d have maned nearly 40 without even a murmur? Not me – shows what I know…

    ps it’s not help to buy it’s help to sell – Osborne wants to get back in and for this one goes to the boomers with the usual bribes.

  • Anonymous

    They know the only way out is a soft default. Luckily they did the ground work: a poorly educated populace. People lack the tools to question the state.

    The UK is certainly in the latter stages of a manged decline.

  • Anonymous

    Hi both,
    Then again, in rural areas there are oil (!) deliveries. Oil fired systems are understood by all, cost 2 -3K to install. GSHP, coming in at maybe 20K, are understood by almost no-one (various official trials show factor of <2 rather than theoretical maximum of 4.2 ish, due to installation issues. On startup the GSHP takes around 50% of your single phase supply, so maybe the lights dim! And in winter, with snow on the ground and network outages, who will be the last to be reconnected? Makes oil and a small generator look attractive if you are rural.
    Dlinn

  • Anonymous

    I was reading somewhere about a German researcher turning electricity into gas. He claimed he could store significant amounts of energy, but the current green electricity costs made storage economically unfeasible. They didn’t report efficiency figures, but you can safely assume losses in energy storage and retrieval.

    They could build thermal reservoirs into water heaters and fridges, and intelligent grids to turn them on when power is available – it seems costly, but may be our future in a world of diminishing resources and rising Chinese consumption.

  • Paul C

    Hi Shaun, I notice that you finish your article with a reference to house prices. You cannot deny that Osborne is playing to the gallery effectively, dismay had almost set in since 2007 amongst owners but suddenly their investment is coming good again. The inflation by what ever measure is compounding very efficiently and this strategy appears to be working.

    Worrying news from the construction industry however, despite what people may say or think, there’s still tons of builders going bust. The big boys are smiling as they shift their old (2007) stock on easy money. The reality is however we shall quickly move to a building oligopoly, main contractors are already being picky about what contracts they bid upon. There’s a shortage of building materials and long lead times. This could be the mother of all pricing routs when we try and build some houses, let alone power stations.

    Keep watching this supply squeeze, maybe we could import builders and materials?

  • Anonymous

    Hi Chris

    I see that you have triggered an intriguing debate on energy prices.

    For my part it is my view that the Monetary Policy Committee should operate against “administered and regulated prices” too. Indeed when I applied to be an external member of the MPC I put that in my application and stated that if selected I would do so.

    I would start by raising the issue publicly and giving it the oxygen of publicity as I feel that it gets far too little…

  • Anonymous

    Hi Dlinn

    Hopefully I am not the only person wondering what GSHP stands for?

    Also the claimed versus the actual performance reminds me about what I have heard about combi gas boilers,are they similar?

  • Anonymous

    A type of tribute act?

  • Anonymous

    Hi Forbin

    The energy price rises were badged as helping us last time I checked. But UK energy policy seems to be in a madhouse where up is presented as down and decisions which are vital are passed over.

  • Anonymous

    Hi Progrock

    The Bank of England used to have a formula which added or subtracted the change in the exchange rate to the interest-rate to analyse monetary conditions in the UK. At that point the exchange rate was at least partly exogenous in that the Bank of England admitted it had some influence over it and responded to it with policy changes. These days it goes “Not me Guv” and denies it…

    So whilst the exchange rate is at times outside our control it is not true to claim it always is and the current stance is misleading at best.

  • Anonymous

    Hi Paul

    This house price game is a repetition of the policy of countless UK governments is it not? Get house prices up just in time for a General Election….As this is getting near to politics I will move on after pointing out that an “independent” Bank of England is feeding the same boom.

    Your oligopoly fears in the building industry are a concern. Oligopolies seem to be the industry structure of choice these days do they not? They have not worked well elsewhere and in fact have often led to the consequences you fear.

    How far do you think that this has gone already?

  • Paul C

    Shaun, I would say it is pretty advanced. Because the focus is on “GDP” statistics, that does not measure the capacity or indeed real world output. We will only know once we try to build stuff (other than London Shard type buildings). I reckon the Poles have gone home, the youth of Britain have not apprenticed and lack the productivity. We shall see.

  • Anonymous

    Apologies to all.

    GSHP = Ground Source Heat Pump.
    A ‘standard’ sized property uses some hundreds of metres of pipe under the ground ( a closed system or loop) to warm the cold water circulated by the refrigeration unit/pump in the property. A sort of reverse air-con. In theory you can use 1 KW from the national grid in the house to gather up to 4.2 KW (ish) of warmth. In practise there appear to be numerous pitfalls such that some installations are getting 1.3 times – so more than the running cost but given the upfront costs … Ouch.
    The ‘other’ ones, Air Source Heat pumps, are intrinsically less efficient than GSHP, but maybe suffer from less installation issues.
    By combi boilers I assume you are referring to condensing boilers, and they do have one similarity in that they both really only produce warm water( 42 C, so big rads or underfloor heating) – they aren’t too efficient if you want water that you would be happy to shower under.
    Never mind, cold fusion in a bucket will solve all our problems.
    DLinn

  • Anonymous

    The air source heat pump (reverse cycle air con) is an excellent and economically sensible heating system where the climate permits. The limitation is that it’s efficiency drops off below 0 degrees centigrade because of icing on the external heat exchanger.

    So it’s great in a Sydney, NSW winter, but impractical in most of Europe.