The devil inside the walls: UK inflation

The devil inside the walls: UK inflation

Joshua Roberts Weekly bulletin October 2017

Last week saw Richard Thaler, the behavioural economist and bestselling author of ‘Nudge’, win the 2017 Nobel prize in economics for his work on how psychological biases influence decision making. Thaler is hardly the first behavioural economist to be given the prize, but he is arguably the most influential and deserving. Government policy across a large portion of the western world now takes its lead from his research to achieve a wide variety of goals, from increasing organ donation to encouraging people to save for their pensions. He has also done a good deal more than most in his field to dispel the incorrect and damaging notion that human beings are capable of acting perfectly rationally when they make economic decisions.

Nevertheless, the Sveriges Riksbank prize in memory of Alfred Nobel (its official title, due to its having been established after Alfred Nobel’s death) is an odd one. Originally awarded in 1969, it was part of a drive to legitimise the ‘dismal science’ and put it on a level pegging with its more respectable cousins. It was therefore unfortunate that, to borrow the words of the 1974 recipient Friedrich Hayek, its inception came at a time when “the serious threat of accelerating inflation […] has been brought about by policies which the majority of economists recommended and even urged governments to pursue”. Last week, we wrote about the consequences of that threat becoming a reality, as terrific levels of inflation in the seventies temporarily reduced living standards for a large part of the population.

Today’s economic models look increasingly sophisticated compared with those of the 1970s, and the economists who employ them increasingly professional. And yet we have once more found ourselves in a situation where inflation is threatening to pick up at a rate which, compared to still-modest wage growth, is really quite alarming. Worse, the situation has once more arisen after years of urging – and unprecedented central bank encouragement in the form of low interest rates and quantitative easing – from many of the same people who now describe it as a ‘nightmare scenario’. So much for learning from past mistakes.

The obvious counterargument is that talk of ‘alarming’ levels of inflation is all a bit melodramatic and unsupported by the data. The latest CPI figure for the US, released on Friday, showed consumer price increases of only 2.2% – scarcely above the 2% target, and even then largely a result of higher gasoline prices in the wake of Hurricane Irma. In the UK, data due to be released tomorrow are expected to put CPI at 3%, which again may be above the target, but is hardly comparable to the stratospheric rates seen 40-odd years ago. Turning to the eurozone, with a fairly lacklustre figure of 1.5%, any impression of inflationary pressure arises only in the context of the bloc’s previous flirtation with deflation.

All of this might be reassuring were it not for the strange disconnect that becomes apparent whenever those in the financial sector talk about inflation. On the one hand, we have now had a number of years in which the vast majority of those who work in the financial markets have been bemoaning the lack of inflation and worrying about how to make it pick up. Talk to those same people during their out of office hours, however – or for that matter pretty much anyone else at any time of the day – and you are all but certain to find that the rising cost of living is one of the main things that keeps them up at night. How could it not be? If they are under 30, the chances are that they do not own their own home whatever their income level, and that their prospects of doing so in the future seem ever more remote. If over 50, they will likely have the same worries, but on behalf of their children. For the increasing number of people forced to spend the lion’s share of their monthly income on rental bills that increase each year, the suggestion that living costs are rising at only 3% per annum is laughable.

Looking at the cost of other essentials, the picture does not improve. This weekend, Sainsbury’s chairman David Tyler warned that a ‘no deal’ Brexit resulting in the UK reverting to WTO trading rules would lead to an average tariff of 22% on foodstuffs imported from Europe. One could reasonably interpret this as the boss of a supermarket business pre-emptively excusing an opportunistic price hike (recall the Marmite-gate dispute of summer 2016). But those who have been examining their grocery receipts over the past couple of years know that those hikes have already started, with prices for meat and fish in particular rising at percentages that are well into the double digits despite reduced packet sizes. The Mirror may have been somewhat sensationalist earlier this year in reporting that prices for meat, fish and poultry had soared by up to 44%, but the sentiment will have resonated with many.

How can these increases be squared with CPI figures that are barely above target? Somewhat bizarrely, the answer is that the index which purports to measure price-increases faced by households allocates a surprisingly low weighting to the items which are actually essential for those households. Combine the costs of housing, energy, food, and public transport, and you are reasonably close to the level of expenditure that cannot be avoided, whatever the circumstances, by those ‘just about managing’ families that the UK prime minister wishes to define her premiership. You also have a basket of goods whose price has risen inexorably over the past few years – but one that accounts for only 25.6% of the key inflation measure used by the UK government and the Bank of England. With the remaining 74.4% taken up by discretionary items (one thinks of the recently added artisan gins, wireless headphones, and the whopping 12.6% allocated to restaurants and hotels) the claim that this is an appropriate statistic on which to base economic policy seems tenuous at best.

For as long as this disparity between economic reality and official figures persists, participants in the financial markets are not going to get any less nervous, and the markets themselves are not going to get any less susceptible to wild swings in sentiment. Nor, for that matter, is the populist wave that has reared up across the western world going to dissipate for as long as citizens feel that the social contract between themselves and their governments has been stretched to breaking point. And the two are inextricably linked: to take but one example, the independence awarded the Bank of England in setting monetary policy has now been decried by key members of the party currently in government, and explicitly given its notice by the shadow chancellor.

It is hardly difficult to find criticisms of the technocratic ‘experts’ who have been operating the levers of the world economy for the past couple of decades. But for those who recall the days of Norman Lamont’s increasing interest rates by 2% in a day in a failed bid to prop up the pound (with a threat to increase them by a further 3% the day after) – and then ‘singing in the bath’ in response to his failure – their greatest crime may ultimately be to hand those levers back to the politicians.

Upcoming Economic Releases
This week sees a number of significant economic releases for the UK, starting with inflation data tomorrow morning (as noted above, CPI is expected to come in at 3.0%, up from 2.9% last month, while RPI is expected at 4.0%). On Wednesday we will see the UK average weekly earnings growth (no change expected from last month’s 2.1%) as well as the jobless claims change, which is again expected to be marginal. Retail sales come in on Thursday, where increases are expected across the board, and the final Public Sector Net Borrowing figure before Philip Hammond’s autumn budget comes through on Friday.

All views expressed here are the Author’s own and are based on information available at the time of writing.


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