We have come nearly to the end of a week that has seen considerable changes in the world economic environment. Two of the world’s major central banks have raised interest-rates with the People’s Bank of China and the European Central Bank both increasing their official short-term interest-rates by 0.25%. And unlike the BBC I do consider China to be one of the world’s “big industrial economies”! It was only a month or two ago it was telling us it was the world’s second biggest economy! Anyway for China this was the continuation of an ongoing trend but for the ECB this was a rise made for two reasons. It had been trying to exit from its monetary stimulus programmes through most of 2010 but instead found it forced (by its political leaders..) to expand them as Portugal,Ireland and Greece went into crisis. Also it now fears a build up of inflationary pressure caused by the boom in fuel and commodity prices that has taken place over the last six months.
Comparing the ECB with the Bank of England
Yesterday the ECB was clear why it had raised interest-rates. It was worried that Euro zone consumer price inflation which on the latest flash estimate has hit 2.6% and it was concerned about the following in particular and the emphasis is mine.
Pressure stemming from the sharp increases in energy and food prices is also discernible in the earlier stages of the production process. It is of paramount importance that the rise in HICP inflation does not lead to second-round effects in price and wage-setting behaviour and thereby give rise to broad-based inflationary pressures over the medium term. Inflation expectations must remain firmly anchored in line with the Governing Council’s aim of maintaining inflation rates below, but close to, 2% over the medium term.
So the ECB considers inflation of 2.6% and rising or put another way 0.6% over target as a trigger. Furthermore it is making an argument that interest-rate rises can help to ameliorate the second round effects of the current commodity and fuel boom. It has not often been true that I have agreed with Mr.Trichet but he has a point here.
What are the differences between the Bank of England and the ECB?
If we look at the position here we can see that the Bank of England has official short-term interest-rates at 0.5%. So before there was any change it was running a policy which had interest-rates some 0.5% lower. Now it has them some 0.75% lower. Therefore its monetary policy stance is much more expansionary than that of the ECB.
We can also compare the stance of the two central banks on inflation as they have they same consumer price inflation measure. The UK has a level of 4.4% compared with the Euro zones 2.6% making an excess of 1.8%! In case you are wondering the UK went through the 2.6% inflation level back in December 2009 when inflation hit 2.9%. Ever since then it has been 1% or more other its official target and now of course is more than double it. This means that the Governor of the Bank of England has to regularly write to the Chancellor of the Exchequer to explain what he will do about it. In case you are wondering this seems to mostly comprise crossing his fingers and incorrectly forecasting that it will fall soon. In reality of course it has continued to rise.
Also I have often made the case that I feel that because of the high proportion of home ownership and because of several technical reasons ( the use of arithmetic rather than geometric means) that the Retail Price Index is a better guide to UK inflation than consumer price inflation. In case you are wondering housing costs make up 23.8% of the RPI. Such a view leads to an even bigger issue as RPI is at 5.5%!
In terms of economic theory the Bank of England has continually claimed that inflation is “temporary” and the result of “one-off” factors. Apart from the fact that these assertions have been proved wrong by the passage of time there is a difference in economic theory between it and the ECB as if you re-read the statement on the ECB’s views you can see. Not only is the ECB worried that inflation may rise but it feels that it can act against “second-order effects”. As I pointed out recently the true policy of the Bank of England was given away by its Chief Economist Spencer Dale.
The foremost task of monetary policy over the past few years has been to ensure that the financial crisis did not lead to a prolonged depression. To have offset these price level shocks would have meant presiding over an even deeper In 2009, our surprise largely stemmed from the extent to which the increase in import prices associated with sterling’s depreciation was passed through into higher consumer prices
As you can see from its policy the ECB appears determined to do its best to avoid such surprises..
Does economic growth make the difference?
There has been something of a media campaign saying that economic growth in the Euro zone is likely to be higher than in the UK.But unfortunately for apologists for the Bank of England this is not true either. The Office for Budget Responsibility forecasts economic gowth of 1.7% in 2011 and 2.5% in 2012 for the UK. The European Commission forecasts economic growth of 1.6% for the Euro zone in 2011 and 2% in 2012. So rather than higher the forecasted economic growth for the Euro zone is in fact lower than that forecast for the UK! I think that some have spent too much time looking at Germany who is indeed growing strongly and not enough at the rest of the Euro zone.
As you can see from the information above there is now an enormous gap between the policies being adopted by the Bank of England and the ECB. We can see therefore that the Bank of Englands intellectual credibility and its honesty is now under fire as well as its forecasting record and its inflation record. When youargue that you can do nothing about sometime it is embarassing to say the least when one of the largest central banks in the world apparently feels exactly the reverse. And just to add to it to use a variation on Mr.Trichet’s words the ECB is a central bank which has hit its inflation target whereas the Bank of England just gets further away from its.
Just to add to the issue both Denmark and Serbia raised interest-rates by 0.25% yesterday.
UK Producer Prices
This morning we have received some further information on inflation in the UK as according to the Office for National Statistics.
Output price ‘factory gate’ annual inflation for all manufactured products rose 5.4 per cent in March 2011. Input price annual inflation rose 14.6 per cent in March.
Now I am afraid that I have to report that care is needed with the ONS statement as it sometimes dissembles. For example it tells us that input inflation has fallen when it originally told us that February input inflation was 14.6%. Where I come from 14.6% is the same as 14.6%! What it means to say is that following a familiar trend it has revised February input inflation up by 0.3% and that the new higher revised figure is above the current one. If you think about it an inflation rise is being presented as a fall! In fact this trend has become so regular it will be a surprise if the March number is not revised higher too.
If you look at the numbers they are concerning as output price inflation is edging higher and input price inflation is above the levels being measured in overheating China (the same China which has raised interest-rates four times…). Unfortunately that is not the full picture as I explain below.
Further Analysis: Some statistical manipulation
In reality the situation is in fact worse than this as the numbers have been “recalculated” by the ONS. I wrote on the 19th of November, the 14th of December, the 14th of January the 11th of February and the 11th of March about a change in the way that the ONS calculates these figures. My conclusion is illustrated below.
This seems innocent enough but I have looked at the numbers for 2010 and this is its impact on the headline output number for produced price inflation for the months of this year so far. They are -0.3%,-0.4%,-0.5%,-1%,-0.5%,-0.7%,-0.8%,-0.5% and -0.6%.
I will leave you to draw your own conclusions! Official recalculations of inflation figures leading to a fall in reported inflation lead to a reduction in the credibility of the figures. Looking at the previous trends for this my calculations lead me to believe that on the old basis we would be reporting output price inflation of 6% this month and input price inflation of 15.4%.
I have two main thoughts for you. The first is obvious from the numbers we have an inflation problem, only nine people and their apologists refuse to see that. The next is slightly more subtle. If you look at the gap between input and output price inflation it is not only large but has been present for a while which means that margins for UK industry must be being squeezed. Apart from the implication for their profitability I am left with the thought that they cannot do this forever and so there is a danger that they may have to accelerate their rate of price rises. If so the Bank of England may be proved right that the current level of inflation is “temporary” as this influence would drive it even higher!
Oil Prices surge again
As I type this the price of a barrel of Brent crude has gone above US $124 and West Texas Intermediate has gone above US $110. Whilst care is needed with short-term moves as they can easily ebb away it seems a high oil price is with us for now. I fear markets may take on the 2008 highs. Apart from the problem for UK inflation policy I would like to remind everyone of the article I wrote about the economic effects of a sustained surge in the oil price on my old Notayesmanseconomics blog on the 22nd of February.
My Policy Prescription
As we look forward there is a continuing and indeed rising danger of inflation becoming embedded in the UK economic system. As our inflation watchdog is either asleep or not doing its job I would like to repeat the policy suggestion that I first made back in the autumn of 2010.
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives and their record is going from bad to worse.
As I type this in a coincidence of timing the radio is playing a song by the group Orange Juice which does coincide with my suggestion.
Rip it up and start again
And as the song goes on it has a message for the Bank of England
I hope to God that you’re not as dumb as you make out….