Monday, February 11, 2008
Price pressures in the pipeline
Posted by David Smith at 10:00 AM
Category: Thoughts and responses

Official figures showed a nasty jump in both input and output prices, with output price inflation now up to 5.7%, its highest since 1991, and input price inflation a hefty 19.1%. Core output price inflation was 3.1%. The figures underline the Bank of England's dilemma. Details here. Also today, the trade deficit on goods and services narrowed to £4.7 billion in December but this was no cause for celebration - the November figure was revised up from £4.4 billion to £4.8 billion. Overall, there was a deficit of £51 billion in 2007, up from £46.4 billion in 2006. Details here.

Comments

Where would this take the "neutral rate"?
Can we (just in principle) say that perhaps, perhaps the effect of the China expansion in the 1995-2005 decade has artificially lowered the inflation expectations, allowing a long period of unusually low IR's?
I know mine is an old, conventional argument, but it is being (perhaps) demonstrated by the events.

Posted by: Michele at February 11, 2008 10:28 AM

Errata: I said "China expansion", please read "China exports"

Posted by: Michele at February 11, 2008 10:29 AM

These were poor figures, though maybe not that surprising in view of the fact that we saw oil hit $100 a barrel. We've been close to this on input price inflation three years ago and the core measure of output price inflation is not yet breaking into new territory. But, as I say, the figures underline the Bank's dilemma. The China effect, in my view, has a long way to run, though its effect on keeping prices down may have been exaggerated. Falling clothing and footwear prices, for example, reflect much more than China. Falling UK prices reflect competitive and regulatory pressure.

Posted by: David Smith at February 11, 2008 10:48 AM

David,
since we are becoming "pen pals", mind if I ask your opinion: is the government, with NR, de facto underwriting the housing market? What is the chance that the EU will/will not find a way of stopping this, despite best effort by the govt to keep NR "off B/S"? With a potential UK Treasury exposure of £100bn, what impact do you think NR has had/will have on the GBP? Are you planning to write a piece about this?
Two references:

http://www.thisismoney.co.uk/mortgages/article.html?in_article_id=430180&in_page_id=8

http://www.moneyweek.com/file/42070/why-house-repossessions-could-double-this-year.html
"It’s interesting to see that against this backdrop, Northern Rock is still writing its ‘Together’ mortgages, which allow anyone buying a property to borrow 125% of its value, plunging them deep into negative equity at a time when house prices are falling. Good to see that the government and you and I, the taxpayer, are propping up a company with such a far-sighted approach to lending, isn’t it?"

Posted by: Michele at February 11, 2008 11:26 AM

If we're going to become penpals, you're going to have to stop citing Money Week. I'd be surprised if Northern Rock has been writing many mortgages, whatever the type. It may the government is looking for a confrontation with the EU on this one but more likely, I would have thought, is that officials have been quietly talking to Brussels about whether the plan is acceptable. As for your wider point, Virgin claims to have stress-tested its plan for something as serious as the early 1990s. Make of that what you will.

Posted by: David Smith at February 11, 2008 11:46 AM

Job cuts, stock market falls, house prices down.

And now inflation taking off.

What was that about no stagflation?

Posted by: Piers Ponsenby-Smythe at February 11, 2008 11:57 AM

As I said, if you think this is stagflation, you don't know what it is. Inflation is in low single figures, growth is at trend and employment is at record levels.

Posted by: David Smith at February 11, 2008 12:06 PM

David,

Great Blog.

Was just wondering what indicators you are watching that would cause you to throw in the towel on the house prices?

The nay-sayers have been wrong for so long, they are beyond boring, however even a stopped clock and all that...

What headline would cause you genuine concern?

Posted by: Stuart at February 11, 2008 12:17 PM

"Inflation is in low single figures"

According to the CPI, yes.

However, I don't think there is a single 'man' on the street that thinks this measure of inflation is accurate.

They see petrol up, coucil tax up, domestic fuel up, food up.

All offset against the non critical items that people can do without.

The cost of living maybe calculated across a full range of products, but when times get hard people need to eat, cloth, get to work and keep warm - and THIS is where the inflation is right now.

Posted by: Dan at February 11, 2008 01:30 PM

"Inflation is in low single figures"

According to the CPI, yes.

However, I don't think there is a single 'man' on the street that thinks this measure of inflation is accurate.

They see petrol up, coucil tax up, domestic fuel up, food up.

All offset against the non critical items that people can do without.

The cost of living maybe calculated across a full range of products, but when times get hard people need to eat, cloth, get to work and keep warm - and THIS is where the inflation is right now.

Posted by: Dan at February 11, 2008 01:34 PM

Dan,
We'll get new figures tomorrow but inflation on all three official measures are in a 2%-4% range, which is in low single figures.

Stuart,
Obviously I'd be looking at what is happening to the house price series, but also whether the fall in mortgage approvals gathers pace, employment and effective interest rates. So far, taking the house price measures together we've seen a definite flattening of prices but not an overall fall.

Posted by: David Smith at February 11, 2008 06:21 PM

This “I knew stagflation; this is no stagflation.” is a bit of a straw man line - us hawks may as well say I knew the Depression this is no depression so no need to cut rates?

We’re not saying there is stagflation now, just that the ground’s looking well set for one.

Real price pressures from energy and Chinese wage growth and currency appreciation;
Increasing inflation expectations;
Growth close to the knife edge thresehold from which it tends to flip to negative;
A Barbereque chancellor who’s prepared to right any cheque to buy public support;
A bank that’s under very real pressure on its primary inflation objectives as, given the state of public finances, is the only institution with the ability to mitigate a recession;

….... The boxes keep getting ticked.

So is probably a fair view that the stag risks are starting to creep past the vanilla slowdown scenarios.

Posted by: Giles at February 11, 2008 08:42 PM

This “I knew stagflation; this is no stagflation.” is a bit of a straw man line - us hawks may as well say I knew the Depression this is no depression so no need to cut rates?

We’re not saying there is stagflation now, just that the ground’s looking well set for one.

Real price pressures from energy and Chinese wage growth and currency appreciation;
Increasing inflation expectations;
Growth close to the knife edge thresehold from which it tends to flip to negative;
A Barbereque chancellor who’s prepared to right any cheque to buy public support;
A bank that’s under very real pressure on its primary inflation objectives as, given the state of public finances, is the only institution with the ability to mitigate a recession;

….... The boxes keep getting ticked.

So is probably a fair view that the stag risks are starting to creep past the vanilla slowdown scenarios.

Posted by: Giles at February 11, 2008 08:42 PM

'These were poor figures'. No. These were TERRIBLE figures.

Mark Twain once said history doesn't repeat itself, it merely rhymes. Well on this basis, the next few years could form the second line of a rhyming couplet - the early 1990s being the first.

Posted by: Sell Everything at February 11, 2008 09:34 PM

You use your description, I'll use mine. Where are these doomsday forecasts among, say, City economists? The first named forecaster in the Treasury's January compilation is ABN-Amro. It has 1.9% growth this year, 2.2% Q4 CPI inflation, 2.6% Q4 RPI inflation, which is bang in line with the consensus.

As for Giles and stagflation - if you're saying there are challenges to this exceptional period of low-inflation stability we've been through, yes there are. You think it is all going to end in disaster. I don't. And, as I say, anybody who lived through proper stagflation would scoff at its use now.

Posted by: David Smith at February 11, 2008 10:14 PM

Up stream price pressures are clearly becoming very pronounced. Alarmingly so. The curves are parabolic. The Bank better hope that growth slows very significantly in the coming months, and that the slow down affects prices as it's models predict. If that doesn't happen, down stream prices (even on the CPI measure) are going to be forced way beyond letter writting territory. CPI, RPI and expectations are on the up already, and elevated expectations are now entrenched. Sustainable investment rule broken, so no room for fiscal stimulous without sending out panic signals.

Option 1) We get the slow down, and it affects CPI as predicted. Slowdown is moderate, but enough to do the trick. Back to goldilocks.
Option 2) We get the slow down, and it affects CPI as predicted, But, slow down turns into recession. Housing market downturn accelerates. Public finances shot. Further rate reductions undermine £.
Option 3) We do get the slow down, but it doesn't affect prices as predicted - origins of stagflation. Very uncomfortable. New policies required.
Option 3) We don't get the slow down; inflation takes off. Breaks have to be slammed on hard. House price crash. Back to boom and bust.
Option 4) We don't get the slow down, and inflation moderates anyway. Nothing in the numbers points this way. Nothing in the world economy points this way. Highly unlikely. Not a reasonable option.

You are right David. the Bank is in a very tight spot. I think it will take the risk, keep lowering, and hope for option 1. The markets think the odds are stacked against it.

Posted by: Tom Gumbrell at February 11, 2008 10:41 PM

David; please can you explain the following on
http://www.heritage.org/research/features/index/country.cfm?id=UnitedKingdom
The freedom from government index says government spending is 44.7% of GDP - presumably at market prices.
The fiscal freedom index says tax revenue is 37.2% of GDP.
The difference of 7.5%, I reckon, must be about £105 billion.

Where does this £105b come from as the media say Gordon is borrowing around £40 billion?

Posted by: Acorn at February 12, 2008 08:47 AM

The figures are a little out. Government spending is roughly 42% of GDP, receipts 39%. See the IFS green budget on www.ifs.org.uk

Posted by: David Smith at February 12, 2008 10:16 AM