Monday, 12 May 2008

What would you do?

Imagine yourself sitting on the monetary policy committee. Along comes one of your Bank of England flunkies and hands you this chart describing recent factory gate inflation.

What would think? Is there a trend emerging here? Is it time for another interest rate cut, perhaps?


CWS said...

If I was on the MPC right now, and would be crapping myself and voting for massive interest rate increases.

Anonymous said...

From moneyweek:

The media is often accused of hyperbole. We journalists might argue, in our defence, that it’s our job to highlight extremes, that it’s the highs and lows that make the headlines.

But on this occasion there’s no need whatsoever for any sensationalizing. The latest UK producer price figures speak for themselves. Indeed they shout so loudly from the rooftops that everyone, particularly the Bank of England’s rate-setting Monetary Policy Committee, needs to sit up and take note.

Because the price of goods leaving British factories rose at a record rate in April, according to today’s release from the Office of National Statistics (ONS), as food and energy costs rocketed. Whilst the latter news will come as no surprise to anyone who has recently had the misfortune to refuel the car or visit the supermarket, these soaring expenses are now finding their way into the official numbers. Factory output prices rose by 1.4% during April, more than twice as fast as expected, driving the annual rate up to 7.5%, the highest since the stats were first compiled by the ONS in 1986.

Even more alarming numerically was the other side of the equation. The cost of raw materials also rose by record amounts, climbing 2.6% month-on-month and an eye watering 23.3% year-on-year, also a country mile ahead of consensus forecasts. Again these were record rises, and alarmingly redolent of the 1970s.

Those of us who can (just) remember the days of such hyperinflation may have thought it had been banished for ever. And in fairness it’s unlikely that we will see a repetition even now, because manufacturing plays such a relatively small role in the UK economy these days.

But danger signs are clearly there. Normally, inflation ‘doves’ love to point to the ‘core’ level of price increases, which excludes food, drink, tobacco and petrol, as this has tended to rise at a much more restrained pace. Yet on this occasion, the doves were in for a big shock. Core output prices advanced a much higher-than-expected 1% over the month to an annualised 4.6%, suggesting that more expensive energy and food aren’t the only reason for the price leaps.

And not to be outshone, the corporate sector weighed in with even more pain. Britain’s biggest energy supplier Centrica, announced it may raise household natural gas and power prices for the second time this year after complaining about “stubbornly high” fuel costs, and suggesting that further industry increases are inevitable.

Clearly the MPC needs to be on full alert. Further near-term interest rate cuts look like they’ve just gone off the menu, certainly in the opinion of several commentators.

"The April producer price data are truly horrible and very worrying indeed for the Bank of England”, says Howard Archer of economic consultancy Global Insight, “raising serious questions as to whether interest rates will be cut from 5% to 4.75% in June despite current signs that the economic downturn may be deepening and widening."

Capital Economics’ Paul Dales said that while the end-customer may largely sidestep the producer price hikes, "the consumer slowdown will mean that retailers will be forced to absorb the bulk of these cost increases in their margins. Nonetheless, this data will maintain the MPC’s reluctance to cut interest rates any faster."

On cue, Scotland’s largest dairyman Robert Wiseman, a supplier to both Tesco and Sainsbury’s, confirmed today that profits were being hit by the company’s inability to pass on to customers the rising cost of both milk and transport.

Of course, the slump in sterling against the euro has been a major factor in lifting import bills. And there was no let up here, with today’s trade figures showing that March imported goods prices leapt by 1.9%, lifting the annualized rate to 10.3%. First quarter import prices for goods excluding oil and erratic items were up by 5.8% year-on-year - the biggest quarterly gain since 1995.

At least the pound rose on the news
Consumer Price Inflation (CPI) is due tomorrow, with the markets looking for slight increase to an annual rate of 2.6%, up from 2.5% in March and compared with the official target of 2%. Then on Wednesday, we’ll hear the thoughts of Governor Mervyn King in the Bank’s quarterly inflation report. It’s probably pie in the sky to expect some last minute rewriting to take account of today’s appalling data - but one can but hope

Anonymous said...

To cut or not to cut,
that is the question....

VADO said...

CPI numbers out tomorrow. That should be interesting. If the number is above 2.5 percent, then the BoE will be in deep trouble.

Mark Wadsworth said...

Alice, really, if you continue posting top stuff like this I shall have to seriously consider promoting you to my Top Twelve Blogs. Keep up the good work.

I'd hike rates by 1% FWIW.

Anonymous said...

I want to see rates shoot up. But then again, everything I own is in cash, so that's self interest talking.

Imagine what another 1% will do to house prices.


DD said...

Mark and Nick
1 percent - it will never happen. The housing market is crashing and it needs help now. The MPC will cut rates.

It is the right thing to do right now. A housing crash will bring the whole economy down. Worry about inflation later.

aSteve said...

I really can't see rates increasing... unless there is a massive political shock... something wild and beyond fiction... maybe "Brown committed to a lunatic asylum and the entire cabinet have disappeared with vast stolen and untraceable funds in Euros" - for example.

The BoE are scared, not IMHO, of any failing of their own - but scared by the consequences for the economy of the currently unpredictable and unmanageable aspects of what is unfolding... and the implication of economic effects outside central bank control.

I think I understand the real problem - and, while I'm refining my ideas daily, I've not found anything similar published.

The real problem is that, for a decade or longer, our economy has only survived (let alone grown) by massive debt expansion. Traditionally, debt expansion would not pose a significant problem with respect to sustainability - because excess new debt would create new money and, in turn, new (price/wage) inflation. Monetary policy has been to target price (and, hence, wage) inflation... which has regulated traditional lending with increased interest rates when price inflation was detected. The natural consequence of this has been to fund lending with securitisation – which, critically, doesn't expand the monetary base – and, hence, doesn't give rise to short or medium term inflation (in the sense recorded by any inflation metric other than asset inflation). This works well (or appears to) while those amassing money amass it at an exponential rate and wish to continue to tie it up in long-term investment in debt... which, I hasten to add, provides them with no tangible increase in wealth – i.e. no fun. Exponentially increasing asset prices (which were essential to GDP growth) demand exponentially more securitisation... which requires an ever greater proportion of the monetary base to be invested in debt on every iteration. A limit was inevitable – a time at which continuing to defer securing tangible wealth no-longer makes sense for a sufficient proportion of the wealthy... I think that limit has been reached – and this is why the market for securitised debt is closed.

The economy will continue to function... but, now debt is no-longer a sane investment, all lending expands the monetary base – which is already bloated by the cash that would otherwise have bought the securitised debt that has recently troubled the banks so greatly. I think that it is this immediate wave of cash that is buoying the stock markets (against my earlier expectations where I assumed that they should fall because their earnings potential will be impaired) and has caused a surge in commodity prices that will necessarily work its way through the system. It isn't clear to me if this surge in commodity prices will stick or be a spike, but I'm sure that they won't continue upwards at their recent pace for very long. This correlates with the BoE view that “inflation” (CPI) will be significantly higher in the short term, but will fall back in the medium term. I can't rule out the possibility that, in 2009 - say, CPI (and RPI) might be negative – or, at least, below target.

For these reasons, while the BoE rate is relevant, it is far less significant than the attention it receives. The BoE rate changes are no-longer mirrored by mortgage rates or bond yields... the only really significant potential consequence of the rate changes, as I see it, is our foreign exchange rate... and even that might not be tightly correlated. I'd say that as a control on the economy, BoE rates have extremely loose linkage... up; down; hold – I can't see it making the difference popular opinion thinks it should. Those who are calling for reduced rates, IMHO, have no idea what effect that would have today – and those hoping for higher rates have no reason to assume that this would effect the credit markets in the way they hope. With next to zero traction and massive potential risk whatever they do, I see the BoE leaving rates unchanged... since to do otherwise risks extinguishing confidence in monetary policy itself... which would be the worst possible outcome.

I think that it is inevitable that rates will need to fall significantly... but that this can only be effective once the current inflationary wave has passed.

Anonymous said...

"Mark and Nick
1 percent - it will never happen. The housing market is crashing and it needs help now. The MPC will cut rates.

It is the right thing to do right now. A housing crash will bring the whole economy down. Worry about inflation later."

The BoE has no business putting a floor under the housing market. It's not in it's mandate and it's deeply immoral. Why only support bad decisions in housing? Why not anything else?

If I buy a Wii for £500 on ebay because I'm a desperate fool should the BoE help me out with a rebate for the difference to the £170rrp?

If I gamble my life savings on black at the roulette table and the ball lands on red, should the BoE print me my money back?

Foolish, mate. Totally foolish. I don't suppose you are a homedebtor then?

"Worry about inflation later" is about the worst thing a central bank can do. That's like jumping off a cliff and worrying about the landing later.


Anonymous said...


I don't think you are as alone in that line as thought as perhaps you think. Most of the deflationista stuff I'm reading is talking about the pricking of an unsustainable 30-year credit bubble now that the debt limit has been reached.

We've just entered into the Great Leverage Unwind. Good piece in the Torygraph about it recently.


powerman said...

When you say 'worry about inflation later' all you really mean is 'prop up the housing bubble as long as you can and then eventually pop it when you're forced to increase interests rates'.

powerman said...

If I was the chancellor of the exchequer I'd be looking at serious spending cuts (starting with non-defensive military engagements) so I'd have room to cut taxes to compensate people for the increase in living costs they'd see from raised interest rates.

The=Haunted said...

Its quite clear to me that rates need to rise. Decreasing rates will only help UK productivity internally while devaluing the pound. These means that everything we import will be more expensive and those things we export (if there is anything!) will be too expensive outside of the UK to buy. Given that we have no UK production to we are dependent on imports and a failure to raise rates will mean ever-increasing inflation. We are better off trying to keep the pound high against the dollar and euro, especially if you consider say the cost of oil when the pound is back at $1.60, if we want to be able to afford to eat travel etc.

I also fail to see a direct link between falling house prices and the downturn in the wider UK economy (i.e falling house prices hinder the economy, I get how it works the other way round :op). Yes there will be losers but surely that will be limited to those that took excessive risks? Perhaps the answer is to do with the fact the entire UK economy is built on credit and that when people can't borrow then they can't buy?

Roy said...

CPI inflation - 3 percent. No way the BoE can cut rates now.

aSteve said...

Nick, if I'm not alone in my hunch (above) about what is happening now, then I am extremely pleased (as opposed to miffed that I'm not first to break it!)

While I've read most of the elements of the above elsewhere, I think it is my interpretation of the macro-effect of securitisation (and why it was doomed to collapse from the outset) that distinguish what I said from the mainstream.

If you have specific references from credible sources, I'd sure like to see my view endorsed... having arrived at if from what I think are first-principles. ;)

Anonymous said...


It was precisely because you argued from first principles that it's interesting, and I'll agree you are coming at this from a slightly different angle (though arriving at the same place).

Here's some recent links I think might help you feel validated