Sunday, October 20, 2013
The inflation balloon's still up in Britain
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Britain has become, once more, a high-inflation economy. Normally as a nation we like to top any European league. But when that league is for inflation rates across Europe, that is more than a little embarrassing.

New Eurostat figures, which the Labour party was quick to pick up on, show that last month Britain had the highest inflation rate in the European Union. Yes, of all 28 EU members states, Britainís inflation rate was the highest.

Britainís 2.7% rate last month was more than double the EU (1.3%) and eurozone (1.1%) averages. Previously high-inflation EU countries, which included Hungary, Poland, Romania and the Netherlands, have come back down to earth.While Britainís rate is close to 3%, more than half of the members of the EU - 15 in all - have prices rising at an annual rate of 1% or less.

If we take a wider comparison, the advanced economies of the OECD (Organisation for Economic Co-operation and Development), only Turkey (8.2%), Mexico (3.5% and Iceland (3.8%) have higher inflation. In the G20, Britainís rate is higher than Chinaís.

Some people are intensely relaxed about Britainís 2.7% inflation rate based on the consumer prices index (inflation based on the longer-running retail prices index was 3.2%). There is, they say, nothing remarkable about 2.7% inflation. In this respect at least they are right.

Inflation has been 2.7% for seven of the past 12 months. It has averaged 2.7% over those 12 months. It is sticky, if not stuck. The inflation target, remember, is 2%.

Actually, 2.7% inflation over 12 months is better than the recent record. In the past 24 months it averaged 3%, over three years 3.4%, over four years 3.3%, over five 3.2%, over six 3.2% and over seven 3.1%. If Britain had a 3% inflation target, this would be acceptable. With a 2% target it is not.

Taking that seven-year average, the level of prices is 8% higher than it would have been had the Bank of England consistently hit the 2% inflation target. As noted here recently, real take-home pay would have held up if inflation had not overshot.

Why is inflation so much higher in Britain? It is easy to blame quantitative easing, though the weakness until recently of money supply growth would suggest that is not a huge factor, and it has not been confined to Britain.

Once it was possible to tell the story through the performance of the pound. Sterlingís weakness pushed up import prices, of food, energy and other globally-traded commodities. Higher inflation,, it seemed, was the price we had to pay for a competitive pound.

All that, however, is a long way behind us. Sterlingís fall was concentrated in the period from the autumn of 2007 to the early part of 2009. The pound is higher now than at its low-point then. To blame the sterling weakness of 5-6 years ago for high inflation since is a stretch too far.

Another explanation is that Britain never really had properly low inflation, even in the glory days of the first decade of Bank of England independence. In those days, indeed, there appeared to be a bigger chance of inflation undershooting.

Inflation then was, however, flattered by the China effect which produced falling prices for goods, before the rise of China began to put big upward pressure on commodity prices. Domestically-generated inflation, in particular service-sector inflation, was never brought to heel.

That remains the case now. Service-sector inflation last month was 3.4%. Some goods are barely rising in price - clothing and footwear inflation was 1.1%, furniture 0.7% - but overall goods prices were up by 2.1% compared witha year earlier. Result: the highest inflation rate in Europe.

At one time a ready excuse for high inflation was pay. But with official figures showing total pay in the latest three months up just 0.7% on a year earlier that is hard for anybody to argue, even bringing in the additional factor of weak productivity growth (which pushes up unit labour costs). Pay is the dog that is not barking.

So what is it, apart from the factors outlined above? For reasons that are not entirely clear, firms appear to be able to push through price rises in Britain in a way they find hard to do in other countries.

Let me give you, courtesy of Richard Ramsey, an economist with Ulster Bank, a couple of figures that I think will amaze. According to the Office for National Statistics the big contributors to Britainís inflation over the past few years have been food and (non-alcoholic) drink; housing, water, electricity, gas & other fuels; and transport (including petrol and diesel).

So what has happened to food and drink prices? In the past six years they have risen by a hefty 35.6% in Britain, enough to make a huge dent in any household budget. We have come to believe, that this is the inevitable result of global factors.

In Ireland, however, which Ramsey is well-placed to monitor, the rise in food and drink prices over that period is, remarkably, just 1%. Irish people are paying the same for food as six years ago, while Britons are paying over a third more.

If we take gas and electricity prices, in the news again following British Gasís announcement of hefty price hikes averaging 9.2%, the difference is also huge. British prices have gone up 61% in six years, Irish prices by 28%.

Unsurprisingly, Britain has had a lot more inflation than Ireland; a 20.7% increase in consumer prices over six years compared with just 3.2% in the Republic. Had Britain had Irelandís inflation, households would never have had it so good.

How do we account for this? The supermarkets will insist they operate in a highly competitive environment, as do the utilities. So too will every other business. But price increases have become ingrained in the culture in Britain, in a way they are not in many other countries.

Of course 2.7% inflation is not particularly high by past standards, particularly for those of us who lived through a bout of near-27% inflation. So should we not chill out about a bit of an overshoot?

No. It it matters. Labourís ďcost of living crisisĒ is opportunistic but inflation is significantly too high for the current rate of earnings growth, when it is far from obvious what will push pay rises higher.

You would not, either, want to start from a position of relatively high inflation when moving into a period of stronger growth. There are scenarios in which stronger growth pushes inflation down but there are plenty more in which the opposiute occurs. Inflation is already too high. We cannot afford for it to go higher.