Analysing UK inflation

Stick with this; it has some gems, and reiterates some things you know but may have filed at the back of your memory. The last section is quite hard to read, but give it a go:

Lower UK inflation provides some welcome good news for real wages

Posted on January 16, 2019

This morning allows us to take a deep breath and move from last night’s excitement which rapidly turned to apparent stalemate to a whole raft of UK inflation data. As we stand the UK Pound has rallied a bit to US $1.288 and 1.129 versus the Euro but in inflation terms that represents a drop as it was around 7% higher versus the US Dollar a year ago. So that is what is around the corner as today the influence will be a bit more than that as the UK Pound was weaker in December versus the Dollar which is the currency in which commodities are priced.

Moving to the price of crude oil there will be a downwards influence on today’s numbers from it as we note a March futures price which peaked at US $84.58 and was more like US $56 around the time the UK numbers are collected. If we look at the weekly fuel prices we see that petrol prices dropped from being around 12 pence per litre dearer than a year before to more like 2 pence. However this gain has been offset to some extent by the way that diesel has become much more expensive than petrol with the gap between the two being around 4 pence in December 2017 but more like 10 pence in December 2018. Does anybody have a good reason for this?

Inflation Targeting

Bank of England Governor Mark Carney answered some online questions on the 9th of this month at what is called the Future Forum. Let me open with a point of agreement.

On your question about the level of the inflation target, long and varied experience has shown that price stability is the best contribution monetary policy can make to the public good.

The problem is that whilst I mean price stability he is being somewhat disingenuous as that is not what he means. Let me highlight with this.

There are good reasons why central banks around the world, including the Bank of England, target a low, positive rate of inflation not no inflation.

As you can see he talks the talk but does not walk the walk and here is his explanation.

 A little inflation ‘greases the wheels’ of the economy, for example by helping inflation-adjusted wages adjust more smoothly to changes in companies’ demand for labour and facilitating shifts in resources between sectors in response to changes in supply and demand. Moreover, a positive inflation rate gives monetary policy space to deliver better outcomes for jobs and growth

So it helps him to look like a master of the universe and helps wages adjust. Seeing as wages have adjusted downwards I hope he was challenged on that point. But there is more.

From a more technical point of view, the official rate of inflation might also over-estimate the true rate at which prices are rising because it is hard to strip out increases that reflect improvements in the quality of goods and services on offer. Aiming for a 0% inflation target would risk forcing the economy into deflation in the medium term.

That is really rather breathtaking! Let me explain why by comparing his “might” by the reality that UK consumer inflation has since the change to CPI as the inflation target in 2003 consistently under recorded inflation via the way that owner occupied housing is ignored completely. They always meant to get around to it but somehow forget until they managed to find a way ( imputed rent) of having one of the fastest areas of inflation recorded as one of the slowest in the new “comprehensive” CPIH measure.

At least he has dropped the effort to claim that relative prices could not move with a 0% inflation target. This is because I kept pointing out that when we had around 0% around 3 years ago there was a big relative price shift via the much lower price of crude oil which had driven it. So it is good that this particular fantasy had its bubble burst but not so good that the Ivory Towers responsible carry on regardless.

Also if we return to the quality issue a powerful point was made by the statistician Simon Briscoe who stood up and stated that each time he bought a new I-Pad it cost him more than a thousand pounds. But whilst he realised each one was better how does that work if he neither needs nor uses the additions or only uses a few of them?

Inflation

As we had been expecting the consumer inflation numbers provided some good news this morning.

The all items CPI annual rate is 2.1%, down from 2.3% in November……..The all items RPI annual rate is 2.7%, down from 3.2% last month.

The main driver here was transport costs as we expected because if we throw in the whole sector then annual inflation was cut by a bit more than 0.2% due to it. Actually slightly more for the RPI as it has a higher weight for air fares. Also the RPI was affected by something a little embarrassing for a Bank of England which had raised Bank Rate in November by 0.25%.

Mortgage interest payments, which decreased the RPI 12-month rate by 0.09 percentage points between November and December 2018 but are excluded from the CPIH.

Of course they are excluded from the woeful CPIH which essentially only includes things which do not exist in its calculations about owner occupied housing and ignores things which are paid. Here is its major player.

Private rental prices paid by tenants in the UK rose by 1.0% in the 12 months to December 2018, up from 0.9% in November 2018.

As you can see even at the new overall lower trend for house price growth (which was previously around 5% per annum ) it way undershoots the number.

Average house prices in the UK increased by 2.8% in the year to November 2018, up slightly from 2.7% in October 2018 (Figure 1). Over the past two years, there has been a slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.

The lowest annual growth was in London, where prices fell by 0.7% over the year to November 2018, unchanged from October 2018.

Comment

There are two entwined elements of good news here as we note first the fact that the annual rate of inflation has fallen and done so quite sharply if we look at RPI. The next is that it has helped UK real wage growth into positive territory on a little more clear-cut basis. Should total pay growth continue to exceed 3% ( it was last 3.3%) then it is hardly a boom but hopefully we will see a sustained rise. At a time when the economic outlook has plenty of dark clouds this is welcome especially as the outlook seems set fair.

The headline rate of output inflation for goods leaving the factory gate was 2.5% on the year to December 2018, down from 3.0% in November 2018. The growth rate of prices for materials and fuels used in the manufacturing process slowed to 3.7% on the year to December 2018, down from 5.3% in November 2018.

Inflationary pressure in the system has slowed.

Moving to measurement I have some hopes for this from the House of Lords Economic Affairs Committee.

Next Thursday 17 January we will publish “Measuring Inflation”, our report on the use of RPI.

It did appear that something of a stitch-up was underway but efforts were made to provide an alternative view as for example I invited them to a debate at the Royal Statistical Society on the subject. They then became quite critical of the way that our official statistician have refused to update the RPI even for changes which would be simple. So fingers crossed! Although of course the establishment is a many-headed hydra.

Sticking with the RPI I referred yesterday to an article in the Financial Times about index-linked Gilts and here is the most relevant sentence.

 This implies inflation of about 3.2 per cent — well above current levels and the Bank of England’s 2 per cent target.

So it implies inflation of 3.2% which was well above the 3.2% the RPI was at the time the piece was written?!