Archive for the ‘Inflation’ Category

Every quarter, we hear the excuses. Inflation was higher than predicted in than previous inflation report because… Growth in GDP was less than expected because…

If there is one thing we have come to expect from inflation reports, it is that the forecasts will be changed – and for the worse.

But, and lean in close – this will be whispered so as not to jinx it – the next inflation report is due out this week, and talk is that the Bank of England may revise its estimates of growth – upwards. It may revise its estimates of inflation – downwards.

On the growth front, the last week or so has seen a fair dollop of good news. The latest Purchasing Managers’ Indices were up, with the sub index tracking new export orders in the manufacturing sector up to its highest level for a couple of years.

The latest news on industrial production, especially manufacturing, was encouraging, and now the National Institute of Economic and Social Research (NIESR) has estimated that in the three months to April the UK economy expanded by 0.8 per cent.

Okay, 0.8 per cent expansion is not exactly a scintillating pace, but compared to what we have become used to, it really is rather good.

As for inflation, according to the British Retail Consortium, shop price inflation was just 0.4 per cent in April, the lowest level since 2009.

It is just that NIESR said underlying growth was not so good, and don’t forget that UK households will only feel better off once wages rise faster than inflation. In the three months to the end of February, wages rose by just 0.8 per cent compared to a year ago. Inflation must fall much, much further, or wages rise much faster before households feel better off.

Incidentally, the latest Bank of England inflation report will have an interim feel about it. The new governor, Mark Carney, will have taken over by the time of the next one. And the August report will look at ideas for loosening the bank’s targets for inflation too.

© Investment & Business News 2013

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It is the great dread. Right now, inflationary pressures are weak in the Eurozone, and deflation is seriously looking like it is back on the agenda. But suppose, just suppose, that from out of nowhere inflation starts to rise, and central banks find that, in order to keep it in check, not only must the rate of interest rise, but the real rate of interest – that is to say relative to inflation – must rise too. It won’t happen, you might say. Why should inflation rear its ugly head at times like these? Well, don’t go so fast.

There are deeper forces at work, and there are reasons to think that in the next few years inflation may return. This is why.

During the boom years central bankers must have had sore vertebrae. They must have because economists, and finance ministers around the world kept slapping it. To let you into a secret, it seems that to an extent central bankers also slapped their own backs – albeit in a subtle way. Mervyn King gave Alan Greenspan’s spine a good tingling; Greenspan let his hand fall upon Mervyn’s spinal column.

The IMF was at it too, slapping away. Why such so much friendly smacking? It all boils down to NICE: that is to say non-inflationary, continuously expansionary. During the noughties, and indeed the late 1990s, economies in the developed world (with the exception of Japan) enjoyed the best of both worlds: strong growth, but modest inflation. Central banks were held up as the reason. Even Gordon Brown received some praise for giving the Bank of England independence, and giving it free rein to do what was right.

These days, central bankers’ savvy is not quite so appreciated, but even so, only a few months ago, they were being cited as the main reason why inflation across the world is so low.

But here is an alternative view for you. Maybe there was another cause of such low inflation. Perhaps there were even two main causes: globalisation and technology. The Internet created unprecedented price competition, while technology helped more efficient production, which led to lower costs. And the rise of emerging markets led to far cheaper manufactured goods, which were imported by the West from factories in Asia.

The part played by commodities in all this confused the picture. The rise of China may have meant cheaper manufactured goods, but also led to a rise in demand for oil, metal and then food. So we had downward inflation pressure on manufactured goods, and upward pressure on commodities. This confused the picture, and may have fooled central bankers, leading them to make mistakes.

But are the forces putting downward pressure on prices still in action? Maybe the Internet effect in creating price pressure via the magic competition was a one-off.

Now take globalisation. Earlier this week, LGIM economist James Carrick suggested that many of the forces that helped globalisation push down on prices are moving into reverse.

He said: “LGIM research shows that [the] increase in global import penetration effectively reached a plateau in 2006, largely due to changes in the Chinese economy. This has grown massively since joining the WTO, but it is also maturing quickly. Greater use of technology and more sophisticated production capabilities mean that China is getting richer and its workers are paid more.

“If the benefits of shifting basic assembly work to China are decreasing, companies will keep production closer to home, an effect we are seeing already with Mexico no longer losing market share in the US. This ultimately means firms can’t keep cutting costs by using cheaper suppliers and therefore will result in higher inflation.”

Mr Carrick reckons there are already signs of this change in the nature of globalisation putting upward pressure on inflation. Well maybe, but to be frank it is early days. We are talking about a trend that may take several years before it becomes obvious.

But would a rise in inflation be a bad thing? After all, inflation is a good way to reduce the real value of debt.

It depends. If we get wage inflation too, then household debt will suddenly look more manageable, and nominal government tax receipts will rise, making government debt look less frightening.

But…suppose wages don’t rise. Suppose prices rise, making us all worse off, interest rates rise making those with debts even worse off, but wages rise more slowly. That would be a nasty set of circumstances.

One thing seems likely. If inflation does start to pick up substantially later this decade, bond prices will suddenly look way too expensive, and we may well see their values crash.

Central banks may have less say over inflation than they are given credit for and QE may be less inflationary than it is assumed. But QE has forced up asset prices, and if external factors then cause a crash, the fall-out would be very unpleasant. If all this happened, maybe, as a punishment, we would need to give central bankers a good flogging.

© Investment & Business News 2013

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The inflation hawks say runaway inflation is inevitable. With record low interest rates and money printing, it is as sure as eggs are eggs.

If that is so, explain this. In the latest data out today from Eurostat, inflation in April was recorded at 1.2 per cent. That is about as alarming as one broken egg in a giant chicken farm.

The inflation rate has halved over the last year – it was 2.6 per cent in April 2012.

A breakdown of the figures is not yet available, but last month inflation in Greece was just 0.6 per cent. In Germany it was 2.0 per cent.

Truth be told, in order to compete, the countries of the southern Eurozone – that is Portugal, Spain, Italy and Greece – have to see prices fall relative to Germany.

This has already happened to an extent in Ireland. If you give the consumer price index in Germany and Ireland a reading of 100 in 2008, then by March this year the index had risen to 115 in Germany, 109.5 in Ireland. In other words, since 2008 German prices have risen by 15 per cent and by 9.5 per cent in Ireland. The economy of Ireland still has plenty of problems ahead, but it has at least partially closed the competitive gap with Germany.

The problem facing the southern Eurozone is that at a time when average inflation across the region is just 1.2 per cent, in order to close the competitive gap they may need to see even lower inflation than that – indeed outright deflation may be the ticket.

When you carry large debts, deflation is about as disastrous as you can get. Imagine the scenario. A country suffering from deflation may be growing in real terms, but in nominal terms contracting. And if nominal GDP is falling, it becomes devilishly difficult – some might say nigh on impossible – to cut debt relative to GDP.

Capital Economics reckons that as a result of deflation, there is a danger that by 2020 debt government debt in Italy and Greece may pass 200 per cent of GDP. And it could be around 170 per cent of GDP in Spain and Portugal. The very process of austerity, and the domination of hawks at the ECB, is creating low inflation across the Eurozone, which in turn may cause debts in Southern Europe to escalate to even more horrendous levels.

Capital Economics reckons there are three possible solutions: default, euro exit, or money transfers from north to south of the Eurozone – in other words, much closer political union.

Italy’s new Prime Minister Enrico Letta is pushing for the latter approach. In a speech yesterday he laid it on thick: “Our destiny as Europeans is common, otherwise it will be made up of individual countries that will slowly decline,” he said.

There is a fourth scenario, however and that is more inflation, especially wage inflation, in Germany,

EU Social Affairs Commissioner László Andor has called for wages to rise in Germany. In an interview with Süddeutsche Zeitung, he said: “Belgium and France have been complaining about German wage dumping.”

Mr Andor warned that the alternative to growth policies entailing rising wages in Germany – perhaps enforced by a rise in the minimum wage – may be mass migration.

In words that might resonate with many in the UK, he said: “Some people compare the situation to America in the 19th century, when there was a mass migration from the south to the prosperous north after the Civil War. In order to avoid this, it is necessary to create growth in the crisis countries.”

Whatever the solution, it is clear that deflation and not inflation is threatening to pulverise the southern Eurozone economy.

© Investment & Business News 2013

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The question is why? Why was it that not so long ago economists were confidently predicting that average wages would rise while inflation fell?

Okay, we know why they thought inflation would fall, and let’s not go over that old ground. But why did they think wages would rise?

According to the latest data from the ONS, average wages without bonuses rose by a mere 1 per cent in the three months to February. Then, if we take into account bonuses and look at what the ONS calls total pay, we find that rose by just 0.8 per cent. So why had economists previously made such bold predictions? Were they guessing?

Even – let’s emphasis this – EVEN if the most hawkish of inflation watchers had been right, and inflation had fallen below the Bank of England’s target, it is likely that right now wage increases would still be lagging behind inflation.

As it is, in February CP inflation was 2.8 per cent. Wages in the three months to February rose 0.8 per cent on the same period a year ago. That means real wages fell by 2 per cent over the period in question. It was the biggest fall in real wages since March last year.

Many economists have argued that the first sign that the UK economy is turning will occur once wage increases begin to outstrip inflation. Well, based on the latest data, all we can say is that point doesn’t look even close.

This all begs the question: why are so many predicting a pick-up for the UK later this year and next? Are they guessing again?

©2013 Investment and Business News.

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It’s kind of pincer movement. On one hand you have a new (or newish – he has held the position before) Prime Minister of Japan: Shinzo Abe, who is changing Japan’s central bank target. On the other hand you have the new governor of the Bank of Japan, Haruhiko Kuroda, going so dovish, they may need to build a special dovecot, just to hold him and his rate setting committee. Mr Abe said he wants the central bank to target 2 per cent inflation.

Mr Kuroda said Japan is entering a “new phase of monetary easing.”

Inflation is in the sight of both Abe and Kuroda. It’s the new double act – like Ant and Dec, but without the screaming celebrities.

The Bank of Japan does in fact aim to double the monetary base over the next two years. The markets love it, with the Nikkei rising sharply on the news, and no doubt the yen will wilt.

There is a snag. Creating inflation is not that easy. In Japan crashing asset prices left consumers and businesses with just about zero confidence, hence they saved. The government can buy bonds to its heart content, but if no one wants to borrow, so what?

It could of course print money and fund massive tax credits; it could scatter money across Japan’s two main islands from a helicopter, but even that may not work. The recipients of this money may, after all, decide to save it.

Funnily enough, however, things may be set to change in Japan anyway. Some inflation over the next year is inevitable thanks to rising commodity prices and planned changes to consumption tax –Japan’s equivalent of VAT.

But something else has been afoot. Japan’s household savings ratio has crashed faster than a dove without wings. These days UK consumers are positively frugal in comparison with Japan’s big spenders.

Maybe the real factor at play here is demographics. When Japan’s baby boomers approached retirement they saved as much as they could. Now they have retired, they have no choice but to spend their savings.

Japan’s demographics may mean internal demand is set to exceed internal supply. Abe and Kuroda may get their wish, regardless of the QE they promote.

If they fail, however, it will be a case of “Good night from me, and good night from him.”

©2013 Investment and Business News.

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One offs. In Monty Python’s ‘Life of Brian’, Reg said: “Apart from better sanitation and medicine and education and irrigation and public health and roads and a freshwater system and baths and public order… what have the Romans done for us?” The answer, of course, was “peace.”

Apart from rising food prices, petrol, gas bills, water, what makes you think inflation isn’t falling? To which the answer might come: “but even core inflation – with food and energy taken out – was 2.6 per cent last month.”

Okay, it’s not quite as catchy as Monty Python, but you get the point. How long must we suffer one-offs before they stop being called one-offs?

In fairness, there is not much of a relationship between monetary policy in the UK and the global hike in food prices. There may be a vague relationship with the price of oil and gas, because QE pushes up asset prices, and some speculators may buy oil as an alternative to holding government bonds. But frankly the relationship may be pretty flimsy.

But QE has influenced UK inflation in another way. It has pushed down on sterling. If it wasn’t for QE, it’s not unreasonable to assume the pound would be much higher in value today. The thing is that when a currency falls, there is kind of inflationary ricochet effect. The price of goods we import when our currency drops doesn’t all happen in one go. The price rises that occurred as a result of sterling falls in 2008 and 2009 are only just beginning to ebb.

Yesterday saw the release of the latest minutes from the Bank of England. Usually these minutes do little more than elicit the odd snore, but this time lurking in the minutes was pretty much the economic equivalent of dynamite.

It turns out that the Bank of England’s Monetary Policy Committee (MPC) is worried about the UK’s poor trade performance and while it accepts woes in the euro are have not helped, it also reckons that the pound is too high.

This is what the minutes stated: “Although the nominal effective exchange rate remained well below its pre-crisis level, some measures of sterling’s real exchange rate provided a less comforting view of the improvement in UK competitiveness.  In particular, a measure based on relative manufacturing unit labour costs was now only 10 per cent below its level in 2007, and just  5 per cent below its average in the decade prior to the depreciation.  It was therefore possible that the real exchange rate consistent with current account balance might be lower than its current value.”

Errr, to put it another way, manufacturing competitiveness is being hit by the price of sterling.

What does this mean? Well is that a hint that next year the Bank of England will put more emphasis on pushing down the pound?

The bank’s next governor  Mark Carney and the Fed – and indeed the Bank of Japan – are apparently coming around to the view that central banks should target nominal GDP – that’s GDP without allowing for inflation. So, it appears the powers that be are becoming more relaxed about the prospect of higher inflation in the short term in order to stimulate growth.

As for sterling, the runes seem to be pointing to falls in the pound in the year ahead.

Here is the snag. Japan’s new government wants a cheap yen. Brazil wants a cheaper real, and indeed its finance minister warned about currency wars two years or so ago now. China is not too keen on the idea of letting its currency rise, and some say Obama wants to destroy the value of the dollar. Oh yes, Greece, Spain, and at least half of the euro area desperately need a cheaper currency.

And by the way, on the subject of currency wars, Mervyn King recently warned of this danger too.

So there you have it, next year will be the year when all currencies will fall. It will also be the year when every team in the Premiership wins all its matches.

The alternative is currency stability. So what might currency stability do for us? Erm “peace”?

©2012 Investment and Business News.

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