Wednesday, November 16, 2005
Low inflation and a dovish inflation report
Posted by David Smith at 12:00 PM
Category: Thoughts and responses

Consumer price inflation fell from 2.5% to 2.3% last month, reflecting both the drop in world oil prices predicted here and an easing of core inflation pressures. Meanwhile, the Bank of England's new inflation report is at worst neutral, at best dovish, on interest rate prospects.


no comments

Posted by: sun at November 17, 2005 01:35 AM

Before anyone gets excited about the possibility of lower inflation (and interest rates) following one month’s figures, please consider the following –

The October RPIX annual inflation number only went down to 2.4% from 2.5%. That was higher than the 2.3% in August. So inflation has come out of the Sept.-Oct. start of winter season higher than it went in. (Inflation in the months of Sept. and Oct. was complicated by retailers delaying the introduction of winter lines in 2004. But the net effect is no cheaper than last year.)

We’re now entering the December mark-up and New Year Sales seasons. Retailers made a huge mistake in 2004 by raising prices for Christmas, only to be forced into heavy discounting in the sales – see inflation graphs.

Retailers won’t make that mistake again. However annual inflation will dip when Dec. 2004 drops out of the numbers and rise again as a normal Jan. and Feb. 2006 are added in.

Last winter Merv said he wanted to wait until Easter to understand what happened over the winter season. He’ll probably say the same gain in 2006 – especially as the expected higher wage and tax rises won't show through until April 2006.

So there’s a lot of action still to unfold before the Feb. and May 2006 MPC meetings.

Separately, I thought Merv was a bit tetchy at times in the Inflation Report press conference. But two surprising questions sprang to mind:

Merv said consumer spending was slower in the second half of 2004 because of taxes and non-discretionary spending price rises. What about the five interest rate rises in the preceding months and the massive drop in MEW income? Why didn’t he mention those and why did no-one ask?

Merv also said that ‘real’ interest rates were the lowest in a generation (or such like). Well the ‘real’ RPIX rate has been low (see above graphs) since July 2001 and is 2.1% now. That’s below the above-3% level that existed before mid-2001. But what is Merv saying? Is he telling businesses that they can expect real interest rates to remain below 3% from now on? If so, that’s pretty staggering.

I though real rates were reduced because of the 2001 recession, 9/11, Enron, the risk of deflation and the need for the US Fed to respond. The Fed seems to be still unwinding those low real rates. Can the UK expect to sustain lower real rates than the US?

P.S. I’ve changed my nom de plume for convenience and to avoid questions about my style of underwear.

Posted by: Sandid at November 17, 2005 11:12 AM

Retailers appear to be discounting a lot already, if the latest retail sales figures (the year-on-year increase in sales value is at a record low) are anything to go by. On the Bank, I wasn't at the press conference but saw the webcast later and thought Mervyn King was referring to long rather than short-run real rates. Watch this space for a piece on the potential rate crossover between the US and the UK.

Posted by: David Smith at November 17, 2005 02:46 PM

Hello everybody.

I'm still concerned about the rising strength of the dollar and the continuing rolling out of fed rate hikes. I can't see how this won't feed into inflationary pressures.

As for oil, I'm sure the cheeky OPEC members will be defending their $50 oil basket as soon as politically convenient.

Am I missing something?

Posted by: Werewolves at November 18, 2005 01:50 AM

The irony of OPEC’s position is that they really, really don’t want to see oil prices so high that they’re in the news. The downside of $70 oil for OPEC is that it stimulates exploration activity in non-OPEC countries. Exploration has started to pick up at last – even offshore UK. (And no doubt there'll be an oil price collapse seven years from now).

But this is no thanks to the UK government. Tony Blair is apparently now holding crisis talks in case we run out of natural gas this winter. It makes you wonder just what on earth this government has been doing about energy for the last eight years – indeed about most things that require competent management?

The New Labour vision has been a failure – because we don’t need a vision. We need real world experience. The only tiny sliver of hope is that Gordon Brown as PM might throw out all Tony’s cronies and install competent people in Cabinet.

No, I don’t think it will happen either.

Posted by: Sandid at November 19, 2005 09:59 AM