Tuesday, 16 June 2009

promising deflation, but getting inflation

Commentators were "surprised" by today's inflation numbers. Before the ONS produced the May rate, the consensus was that the headline number was going to tumble to 2 percent, with some brave souls even suggesting 1.8 percent.

Instead, the May rate came in at 2.2 percent. Only 2.2 percent? Is it safe to conclude that inflation is beaten and that the UK economy is only an inch away from deflation? Sorry, today's number offers no such comfort.

Take a look at the monthly inflation rates. From October to January, the CPI was falling in absolute terms, largely because of the rapid fall off in oil prices, which were coming of a $147 a barrel peak.

In February, just as the Bank of England began printing money, the inflation rate turned around. Since then, the CPI index is up 1.8 percent.

Yes, that is right, in just 3 months, UK prices are up almost 2 percent. Annualise that rate, i.e. multiply by 4, and you begin to see that far from deflating, the price level is actually rising quite rapidly. The four month mild deflation means that this sudden upswing in prices is obscured in the 12 month rate.

In May, prices jumped 0.5 percent. Annualise that rate and we get something like a 6.5 percent inflation rate. So, today's number was really rather bad, and hence the "surprise" felt by many commentators.

Today's number wasn't a "one-off". Over the last four months, the CPI has increased by an average of 0.5 percent. What does that kind of monthly rate mean for short term inflation dynamics. The following chart looks at the 12 month inflation rate assuming that the monthly rate increases by 0.3 percent a month until the middle of next year. This rate is a conservative assumption, since it is a full 0.2 percent lower than the current monthly rate. As the chart implies, if we see this kind of monthly inflation, then we will see a sharp jump in the rate next autumn as the 2008q4 deflation effects fall out of the CPI index.

Today's inflation numbers must have made uncomfortable reading for the MPC. Insofar as there was any deflation, it stopped in January. Now, the monthly inflation rate has picked up sharply and if it maintains its current momentum, then by Christmas the BoE governor will again have to write love letters to the Chancellor, explaining why he has missed the inflation target yet again.

Time to raise those rates, I think.


RF said...

Anything to say Young Mark?

Anonymous said...


mike said...

Yes time to raise those rates. Seems those sad currency traders are also expecting rates to rise with new highs being set on the Pound currency exchange rates.

Currently at 1.18 Euro/Pound (6 month high) and 1.64 USD/Pound (7 month high). This is a good thing for those living abroad on UK based income, but might just kill off any remaining manufacturing we have in this country.

APL said...

Mike: "but might just kill off any remaining manufacturing we have in this country."

Mike, how much of the economy is entirely within the UK?

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Anonymous said...

More inaccurate and uninspired commentary from Alice. She acknowledges the link between falling oil prices and inflation last year, but utterly fails to mention the rising oil price this year - from $30 to $70 a barrel.

As she ascribes falling CPI to falling oil prices, surely she should mention rising oil price might have something to do with rising CPI? Guess that wouldn't suit her trite argument though?

Then she makes the asinine extrapolation to guessestimate the full year inflation figure based on only the past three months or only a single month. Why? It is methodically unsound and bucks all common sense - yet it helps form her argument the Bank of England needs to raise rates.... this is intellectually dishonest at best.

Looking at her own chart it is easy to see the volatility of the monthly numbers and there is no discernible trend whatsoever. Why is Alice assuming one exists and extrapolating it out into next year?


Markbaldy said...

If anyone believes the official inflation figures then they really do deserve this crass government !
I for one, reckon that inflation is over 10% - when you consider cost of food and essentials... and not a basket of non essential items they use to produce their official figures.
Sure, petrol is cheaper than a year ago... for now anyway !
It will go up and so should interest rates !!!!!!!

Anonymous said...

Let's look at the 'driver' forces of the UK economy, not the fantasy manipulations of New Labour (keeping interest rates down to please the constituency of the indebted and home owners). The pound needs to strengthen because in the last instance, most of the UK's economy is outside the UK and needs a strong pound to function. And in order to re-plenish the banks and lending, a strong pound and high interest rates are required to attract foreign capital. These drivers will push the BOE's hand and they will have to whack rates up past 10 percent by the end 2009.

Anonymous said...

"In July, the money supply increased by 0.9 percent, which should be sufficient to ensure a double digit annual growth rate.

What about M4 lending? It is growing at 14 percent a year. With monetary growth numbers like this, inflation will be going in only one direction - up."

Alice Cook, 20th August 2008.

Outcome: Inflation started falling before the ink had dried on Alice's prediction.

"Bringing interest rates down to 2 percent has set off inflation. It won't stop until the Fed calls time and raises rates."

Alice Cook, 19th August 2008

Outcome: The Fed carried on cutting and American CPI annual inflation fell to its current -0.7%

"Nevertheless, the question remains what is going to make inflation come down? There is a widespread view that that slower growth will do the trick. While a dramatic decline in growth will eventually exert downward pressure on prices, I think that many commentators haven't appreciated just how large the slowdown needs to be for inflation to fall …

Unfortunately, the BoE still think that a modest and temporary slowdown in growth (will) beat down on inflation without the MPC having to throw a punch. I doubt that inflation is going to go away without a serious fight."

Alice Cook, 14th August 2008

Outcome: Inflation went away without a serious fight.

"Yes, we are one year into the credit crunch, which was supposed to reduce lending activity and bring inflation down, and during the last three months, the US is running a double digit inflation rate. So much for deflation.

If anyone thinks that things are suddenly going to turn around, just take a look at US policy rates"

Alice Cook, 14th August 2008

Outcome: Things suddenly turned round.

"The August 2008 forecast (BoE inflation forecast) expects a much steeper and more rapid decline in inflation. Some positive action on interest rates would give some credence to the steeper adjustment path outlined in today's report.

Therefore, my money is on a brace of rate hikes this autumn. In the circumstances, with inflation racing towards 5 percent and beyond, it would be the right thing to do."

Alice Cook, August 13th, 2008

Outcome: Alice lost her money, the BoE declined Alice's invitation to raise rates, inflation didn't "race" beyond 5% - it fell rapidly.

Alice's calls for higher interest rates are motivated solely by a desire to see house prices fall.
It would be more intellectually honest if she were actually truthful about this. We could then have a debate about the extent and desirability of such falls and the means by which they could be achieved. Doubtless once we were three nanoseconds into the debate Mark Wadsworth would raise the issue of LVT! However it is intellectually dishonest to call for higher interest rates to counter an inflation threat which does not yet exist.

Like Alice I would also like to see house prices continuing to fall. However, having been a victim of a previous recession I don't want to see unemployment forced up to the 4mn mark just so my kids can have a bigger garden and a play room. In any case, it's unnecessary. Rising unemployment will ensure that house prices continue to fall (and will keep inflation in check for the time being). There will shortly come a time when interest rates need to rise, However it isn't now, and it certainly wasn't last August (see above).

Young Mark

Chris Roland said...

This is a worrying increase, but not entirely unexpected. With the markets fluctuating as they are, we were always looking at uncomfortable inflation OR deflation, whichever comes first. Even worse, it seem experts are now set on the interest rate: we're in a miasma now. See the article about interest rates here: http://money.sky.com/mp/features/news/2009/06/17/Experts-unanimous-on-interest-rate.html

Anonymous said...

And the printing presses are still roaring away. Do you really think Broon will rein them in, with an election now on the horizon whether he will or no?

See that light at the end of the tunnel?

It's the inflation express, thundering towards us.

Anonymous said...

Your Mark - great work.

I agree completely - Alice describes herself as a "bitter renter" and this completely clouds her judgment. This is evident in all her posts.

She needs to realize house prices are not the be all and end all of the economy, nor life itself.

Anonymous said...

An interesting post on inflation. I also disagree with Alice's inflationary predictions.
However, to suggest that employment is more important than housing ignores the very real truth, that many people in the UK are better off taking their risk of unemployment in return for lowered costs of housing i.e. for me, I am not working, but comparing my 2007 working and unable to afford property, with today, not working but house prices coming down 30K per annum, obviously I do better with this situation assuming I can return to the labour market at some point. I am getting paid the equivalent of 30K tax free a year if you take the view that I ultimately get on the property ladder.

For a property owner scared of losing their job and foreclosure, to argue that we are somehow in a caring collective society is absurd. Property owners were prepared to deliberately restrict access to housing in order to inflate the values of their assets.

I do not accept a social obligation to those whose failed plan was to make me an indentured worker. If mass unemployment is required to break property owners, fine, bring it on.

Anonymous said...

Would I accept a 20% reduction in my wage, in return for a 50% fall in housing costs.

Absolutely YES.

Those who failed to carry out an accomodation squeeze against me put your heads on the block, good riddance to bad rubbish.

Anonymous said...

It is going to be the re-pricing of all re-pricings. We are seeing our wages and standard of living coming in line with China's. That means we have a long way to go - down. In such an environment, it would be better to get the economic restructuring happening now, and have a couple years of pain and hard work, instead of decades of entrenched groups like over-valued homeowners hanging on for dear life, constantly asking for government bailouts. The Dutch offer a good example: in the early 90s recession, they traded salary decreases for greater security and greater government support for restructuring the economy. And it worked.

Anonymous said...

Anon at 10:41, if you don't have a job who exactly do you plan to service your mortgage? You do realise to buy a home you need to make these things called "interest payment" or have you saved enough from you Giro to buy outright?

Anonymous said...

Ummm...nobody is going to buy now, next year, for a long while. I am aware of those things "interest rates", you have them, I don't. You seem to have a temporary reprieve by diminishing the rate of return for innocent savers. Good luck with that. I don't think that will be enough. Housing exclusionistas need to be broken on a wheel of debt, falling rather neatly into the hole dug by themselves.

In the fullness of time, I hope to be able to cover the interest rates required by three times my salary, as my parents, and their parents did.