Monthly Archives: November 2016

Latest UK inflation data – October 2016

UPDATE: Listen to Pete Comley talk about the latest data on share radio:

https://www.shareradio.co.uk/podcasts/why-did-the-inflation-rate-fall-unexpectedly-last-month-15-nov-16/PodcastPlayer

Contrary to some economists predictions, inflation did not appear to rise in October. However as I pointed out last month, the CPI index had got ahead of itself. 1% was not a true reflection on inflation in September because of problems in the way ONS calculate clothing prices.

In a similar way, clothing has acted as a negative influence on inflation this month, whose correct CPI value is probably now more like 1%. It was also held back by declines in some gaming/toy prices – another volatile element. Balanced against this, petrol prices were up, in contrast to last year when they declined. Unusually furniture costs went up in October, although longer summer sales than normal are partly to blame for this apparent rise.

Food prices generally as still exerting a strong negative effect on the inflation rate (-2.4%). Many vegetables are still being used in supermarket price wars with the prices of everything from broccoli to cabbage and mushrooms reaching record low levels for recent times. That said, it is interesting that fish prices were sharply up this month – the UK imports more than two-thirds of the fish we consume. As an example, BirdsEye last week were trying to increase fish finger prices by 12%.

Future inflation

Today’s data shows evidence that inflation is going to rise in the future though. This can be found in the Producer Prices Index. Input prices rose 12% in the latest year and by 4.6% in October alone. Factory gate prices are now rising (+2.1%). This is backed up by a series of announcements in the media over high profile increases such as Typhoo teabags, Marmite, crisps and Persil. Apple has increased its computers by 10% too.

The pass-through of changing exchange rates is complex and highly variable. For example, the decline of the pound from $1.7 to $1.5 in 2014 had little impact on UK prices. But I feel this time may be different. The recent declines in the value of sterling come after a general decline in the last few years and could be ‘the straw that breaks the camel’s back’ for many companies. Add to that, Brexit is a great excuse to justify hiking prices this time. Usually exchange rate changes often go unnoticed by consumers and so can be difficult to use as an argument for price rises.

The other factor that is going to weigh heavily on the headline inflation rate in the coming months is petrol prices. Last December they declined to just 103p a litre. This year that figure is probably going to be more like 117p ie 13% higher. The impact on the index will be even greater as last year prices were declining and this year they are increasing. Given all this, there is a strong likelihood of seeing CPI in excess of 1.5% in the December data (and 2.5%+ for RPI).

CPIH

In the wake of Trump’s victory last Thursday, ONS published (buried??) news of their plan to replace CPI with CPIH as their headline measure in March 2017. This could be a very unwise move on a number of grounds:

  1. CPIH has been a measure that has been shrouded in controversy since it was launched. ONS had so much difficulty with it, they had to withdraw it as a designated statistic in 2014 and to this day, it has not regained that status.
  2. The H in CPIH stands for housing. However the elements included in it and how they are calculated do not correspond with what the public would expect from an inflation statistic including “housing”. Firstly it excludes house prices completely. Secondly instead of measuring housing expenses directly (such as mortgage costs, building insurance, maintenance, etc) as people experience them, it uses a complex alternative measure based on rental equivalence. Thirdly, despite arguing it is not possible to cost housing items directly, it then has just added in council tax as a complete exception to this rule, making CPIH even more of a mess.
  3. The relationship between CPI and CPIH is complex. However for the last two years it has been about 0.3% higher than CPI. If this persisted, it is unlikely that government would want to use it either as a measure of their success in controlling inflation nor to index pensions and benefits (as it could result in higher expenditure). Linked to that, it would make it more difficult for the Bank of England to meet its 2% target.

If the ONS wish to improve on the EU’s invention of HICP (which we call CPI) in this post-Brexit world, they might be far better to revert to the British measure of RPI. Although it too has its issues (see here), it generally more accurately reflects inflation as experienced by consumers as it is usually higher than CPI (due to its simpler method of calculation) and it already weights in housing costs and house prices.

The latest ONS data can be found here.

Bank of England Inflation Report – November 2016

UPDATE:

Listen to Pete talk about the report on Share Radio:

Latest inflation predictions

The latest BoE Inflation Report today showed that the Bank now expects inflation to be higher in the coming years and particularly in 2017. They are now predicting CPI will rise to 2.7% this time next year as opposed to 2% which they said in August. They also increased their inflation predictions for 2018 to 2.7% (2.4%) and do not think it may return to the 2% target until 2020.

Yesterday we had the National Institute for Economic & Social Research (NISER) also raise its forecasts with headlines of 4% predicted inflation next year.

The factors affecting future inflation

There is no doubt that the continued decline in sterling is going to have a significant impact on UK prices. According to the BoE today, the sterling weighted index was down 20% in a year (and it is even more so versus its peak last August). Furthermore, some traders think the current level is a flag on a continued downtrend towards $1.1 and €1 = £1 i.e. a further decline of over 10% at some point during the Brexit negotiations.

It is worth noting though that declines in the pound do not translate simply into rises in the CPI inflation rate. Firstly only a proportion of the prices in the UK are directly influenced by exchange rates – primarily those that are imports or commodity related. These represent about a third of the index. However even here, many importers and companies either choose not to pass all the increases through or may delay doing so (especially if they have forward contracts fixed at pre-Brexit levels).

Pass through depends a lot on the state of the economy and the sectors affected. Usually for motor fuels and gas/electricity prices the pass through is quite quick and in full. In recent days we’ve seen some companies that feel they have bargaining power also pass through the full impact eg Apple and Microsoft. It remains to be seen if the same happens in supermarkets for foods and consumer goods – the Marmite wars indicate pressure is increasing though.

According to Mark Carney today, consumer spending has been so far more resilient than expected post Brexit. That would imply a higher and faster pass through may be attempted on imported goods.

So returning to inflation predictions, next year’s outturn will depend not just on what happens to exchange rates in 2017 but also global commodity prices. Historically, the latter is probably the most influential factor on short term UK inflation rates. Therefore if the oil price was to manage to rise towards $60/barrel this might put even more pressure on CPI than economists are currently factoring in.

Of the two inflation predictions out in the last 24 hours, I expect we’ll see inflation closer to NISER’s 3.8% in 2017 than the Bank’s 2.7%. The Bank has a long track record of predicting inflation two years out will be either exactly at their 2% target or near it. For the vast majority of the decade after 2004, they consistently under-estimated inflation, sometimes by a very wide margin.

Money supply effects on inflation

Another reason to believe inflation is going to run higher in the coming years has not been talked about much in the media. UK inflation over the very long run (i.e. 100 years) has had a strong relationship with the money supply – see here. On Monday we saw figures published showing that the broad UK money supply (M4x) had soared 10% from July-Sept (and 7.7% over the year). Although the pass through of money supply changes is complex, not least because they often go into asset prices first, they will add to continued pressure on UK prices in the years to come.

Implications of the increase in inflation

It is worth considering who is going to win and lose with this burst of inflation.

The key winners are:

  • Government: Tax revenues will rise in line with real inflation (RPI) yet the low interest rates and QE from BoE has ensured that cost of servicing government debt is significantly lower. Furthermore inflation will erode the real value of government borrowings and decrease important debt-to-GDP levels.
  • Other debtors: Major debtors such as corporates and mortgage holders will see the value of their debts decline in real terms. This may well put further pressure on house prices with resulting misery for first-time buyers.

However, for every pound gained by a winner, there is corresponding pound lost by someone eventually. Some of the key losers are:

  • Cash holders: The BoE has ensured interest rates are near zero. If CPI runs at 3-4% CPI for four years (i.e. closer to 4-5% real RPI inflation), purchasing power could be eroded by up to a fifth. That is a staggering level of stealth tax on British companies and savers.
  • Workers: Wages are currently growing at 2.3% a year. That equates to about the current level of RPI inflation (2%). If we see CPI at 4% (RPI = 5%) in 2017, many workers will see a significant decline in their standards of living as wage increases will not keep up. Again compound effects over the coming period of high inflation, could start to have a marked impact on consumer spending – a fact the BoE was highlighting today.
  • Pensions: The impact here is via real bond yields which are the bedrock of most pension savings. The rise in inflation will erode real value of defined contribution pension pots for millions of workers. It may also impact on real annuity rates and more importantly the real value of pensions people receive if they have not inflation protected their annuity.