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| The cost of living crisis is down to Brexit. The chickens are coming home to roost | |
| (35 minutes later) | |
| First, a little primer on inflation. The UK inflation rate for June 2017 as measured by the consumer prices index (CPI) was 2.6%, the Office for National Statistics announced this week. That is to say that the cost of living, measured by prices of a representative “basket of goods” from computer games to children’s clothing, rose by 2.6% over the prior 12-month period, although it was down from 2.9% the month before. | First, a little primer on inflation. The UK inflation rate for June 2017 as measured by the consumer prices index (CPI) was 2.6%, the Office for National Statistics announced this week. That is to say that the cost of living, measured by prices of a representative “basket of goods” from computer games to children’s clothing, rose by 2.6% over the prior 12-month period, although it was down from 2.9% the month before. |
| This rise was less than experts had expected. But the predictions are that we will see numbers over 3% later this year. After that inflation is expected to fall back again towards zero. | This rise was less than experts had expected. But the predictions are that we will see numbers over 3% later this year. After that inflation is expected to fall back again towards zero. |
| Over the past few years we have become used to inflation being very low – indeed, it averaged 0% in 2015. It seems that worries about falling prices, or deflation, have gone for now. Most other countries in the world are experiencing low and falling inflation, including the euro area with a rate of 1.3% in June, down from 1.9% a couple of months ago. The US is at 1.6%, down from 2.8% earlier this year. | Over the past few years we have become used to inflation being very low – indeed, it averaged 0% in 2015. It seems that worries about falling prices, or deflation, have gone for now. Most other countries in the world are experiencing low and falling inflation, including the euro area with a rate of 1.3% in June, down from 1.9% a couple of months ago. The US is at 1.6%, down from 2.8% earlier this year. |
| The main reason inflation is rising in the UK is because of Brexit. Import prices have risen because of the fall in the value of the pound, which is down about 13% to the dollar from $1.49 on 23 June versus $1.30 today, hence inflation. | The main reason inflation is rising in the UK is because of Brexit. Import prices have risen because of the fall in the value of the pound, which is down about 13% to the dollar from $1.49 on 23 June versus $1.30 today, hence inflation. |
| Inflation is the rate of change of prices. To illustrate it simply, if prices last year were £100 and this year they are £102 then prices have risen by 2.0% (£102/£100). If next year prices rise to £105 then inflation is £105/£102=2.94%. So even though prices rose in both years the rate of change of prices has increased. | Inflation is the rate of change of prices. To illustrate it simply, if prices last year were £100 and this year they are £102 then prices have risen by 2.0% (£102/£100). If next year prices rise to £105 then inflation is £105/£102=2.94%. So even though prices rose in both years the rate of change of prices has increased. |
| The Brexit vote was largely unexpected and was not priced in by the markets. The fall in the pound occurred because markets felt that UK prospects had deteriorated as a result of the vote to leave the EU. Experts predicted that with this big rise in uncertainty consumers would start to save more and spend less as a precaution, but they didn’t. Consumer spending held up and unsecured borrowing rose sharply. That is why the economy took longer to slow than many, myself included, expected. | The Brexit vote was largely unexpected and was not priced in by the markets. The fall in the pound occurred because markets felt that UK prospects had deteriorated as a result of the vote to leave the EU. Experts predicted that with this big rise in uncertainty consumers would start to save more and spend less as a precaution, but they didn’t. Consumer spending held up and unsecured borrowing rose sharply. That is why the economy took longer to slow than many, myself included, expected. |
| But that is now in full reverse as prices are rising faster than wages, which are growing at under 2%, so real wages, adjusted for price rises, are falling once more. Pay settlements are coming in at a norm of 2%. | But that is now in full reverse as prices are rising faster than wages, which are growing at under 2%, so real wages, adjusted for price rises, are falling once more. Pay settlements are coming in at a norm of 2%. |
| There is little or no likelihood that wage growth is going to pick up beyond 2% any time soon. Consumers will retrench and spend less and demand will drop. The savings rate, which is at historically low rates, will start to pick up. Workers will continue to hurt. According to official data real wages are 7% below pre-recession levels, so pay packets buy less. | There is little or no likelihood that wage growth is going to pick up beyond 2% any time soon. Consumers will retrench and spend less and demand will drop. The savings rate, which is at historically low rates, will start to pick up. Workers will continue to hurt. According to official data real wages are 7% below pre-recession levels, so pay packets buy less. |
| Business confidence has fallen and is now at its lowest point for almost six years | Business confidence has fallen and is now at its lowest point for almost six years |
| The economy in 2017 has started slowing. UK retail sales grew at the slowest rate for four years in June. The index of production was estimated to have decreased by 1.2% in the three months to May 2017 compared with the three months to February 2017. In the first quarter of 2017 the UK economy was the slowest growing economy in the G8 and the EU28. Business confidence has fallen and is now at its lowest point for almost six years, the economic consultancy IHS Markit reports. | The economy in 2017 has started slowing. UK retail sales grew at the slowest rate for four years in June. The index of production was estimated to have decreased by 1.2% in the three months to May 2017 compared with the three months to February 2017. In the first quarter of 2017 the UK economy was the slowest growing economy in the G8 and the EU28. Business confidence has fallen and is now at its lowest point for almost six years, the economic consultancy IHS Markit reports. |
| The question for the UK’s monetary policymakers is what they should do when inflation is high but the economy is slowing, as occurred in July and August 2008, although on a much worse scale. Inflation may be bad – it erodes the value of people’s savings – but low growth and unemployment are much worse. There were three votes (out of eight, with one seat currently vacant) for an interest rate rise at the last meeting of the monetary policy committee (MPC), but that looks to be a huge mistake, in my view. | The question for the UK’s monetary policymakers is what they should do when inflation is high but the economy is slowing, as occurred in July and August 2008, although on a much worse scale. Inflation may be bad – it erodes the value of people’s savings – but low growth and unemployment are much worse. There were three votes (out of eight, with one seat currently vacant) for an interest rate rise at the last meeting of the monetary policy committee (MPC), but that looks to be a huge mistake, in my view. |
| If the MPC raises rates to deal with inflation this would cause the economy to slow even faster, as the price of money rises. Interest rate rises could easily push the UK back into recession. | If the MPC raises rates to deal with inflation this would cause the economy to slow even faster, as the price of money rises. Interest rate rises could easily push the UK back into recession. |
| My advice would be that the monetary police committee should wait and watch and see if the economy worsens. If it does then it should cut rates and do more asset buying. The big problem is markets have no idea what a Brexit future will look like. In economic terms, the Brexit chickens have started to come home to roost. | My advice would be that the monetary police committee should wait and watch and see if the economy worsens. If it does then it should cut rates and do more asset buying. The big problem is markets have no idea what a Brexit future will look like. In economic terms, the Brexit chickens have started to come home to roost. |