The worst of the rise in inflation is likely over. But as the economy stutters, and with Brexit chaos looming, wage earners will be waiting a long time for any real reliefby George Magnus / June 20, 2017 / Leave a comment
The recent election, the Grenfell Tower tragedy and Brexit negotiations, which start this week, continue to dominate our news and send shockwaves through the land. The economy continues to rumble on, regardless, but all is not well. Last week, the inflation report for May revealed that the annual rise in consumer prices had risen to 2.7 per cent. Only a short time ago in 2015, the annual change in the index was struggling to remain above zero, and actually failed to do so for a few months. Now it is the highest rate for four years. As if on cue, the Bank of England’s Monetary Policy Committee (MPC) met soon afterwards, and voted 5-3 to keep interest rates unchanged at 0.25 per cent. The MPC hasn’t had this close a call in quite some time. So, is inflation getting to the point, where to cap everything else, higher interest rates are on the way?
The answer to this is almost certainly no—but while inflation won’t bite much harder than it is now, wage earners aren’t out of the woods by a long shot.
The inflation figures were affected in May specifically by air fares going up, a rise in energy costs, and generally by the so-called “pass through” of Sterling’s depreciation in the wake of the referendum result this time last year. In other words, the weaker pound has made everything we import more expensive, and while some companies absorb some of these extra costs in their profit margins, much is passed on to other companies and of course to consumers. We should be over the worst of the acceleration in inflation. Input prices, or the index of prices paid by companies was still 16.6 per cent higher than a year ago, but the rate has fallen from almost 20 per cent in January. Nevertheless, it would be a mistake to assume that the rise in the Consumer Price Index has ended. The Bank certainly expects it to rise to over 3 per cent this autumn, and we should not forget that Sterling has weakened again in the last few weeks.
“Real average weekly earnings have been 0.4 per cent lower than a year ago. By May and June, you can imagine this depressing statistic will be even worse”
The Governor of the Bank, Mark Carney, is duty bound to write a letter to the Chancellor Philip Hammond if the inflation rate rises to more than 1 per cent over the mandated target of 2 per cent to explain what has happened, why, and what happens next. However, this is all pretty well rehearsed. The pick-up in inflation is predominantly Sterling-related, and once this has worked its way through the economy, inflation should then start falling again. Hence the decision to keep interest rates unchanged again, although many of us are scratching our heads wondering what on earth the three MPC members, who voted for a rise in interest rates, are seeing in their crystal balls. We understand the MPC is supposed to be vigilant, and pre-empt rising inflation before it plants strong roots, but really?
To get a self-feeding inflation, you need to have something called a transmission mechanism. This could take the form of a continuous and pervasive rise in costs, or it might be overheating in the economy so that excessive aggregate demand growth pulls up prices. Neither of those two conditions exist. The commonest transmission mechanism is wages, so that higher prices force wages up, which push prices up, and so on. Yet, last week’s labour market statistics showed that average weekly earnings in the three months to April were 2.1 per cent higher than a year ago, just 1.7 per cent if you exclude bonuses. The Office for National Statistics also said that real average weekly earnings were 0.4 per cent lower than a year ago. By May and June, you can imagine this depressing statistic will be even worse. Inflation has risen, and there doesn’t appear to have been any marked change in the environment for wages and salaries.
“The government has gone mercifully quiet with its “Brexit means Brexit” mantra, only for a new meaningless phrase about ‘Brexit for the many, not the few’ to come from the lips of the opposition”
Put another way, real consumer spending is being squeezed now by the rise in inflation, brought on by the Brexit currency depreciation (as widely forewarned, it should be said.) Looking forward, the squeeze should ease once inflation has peaked just above 3 per cent and then starts to slide. But in real terms, most wage and salary earners will have to wait quite a long time before they get any relief, especially if money incomes continue to grow so slowly.
There are currently few reasons to expect that to change. Last week also brought news that retail sales in May dropped by 1.2 per cent, and were only 0.9 per cent higher than a year ago, the slowest for four years. I have mentioned before that overall consumption is being restrained by both higher inflation and the fall in the household savings rate to a record low, and that firms’ capital spending is trendless. The economy, then, is slowing down from the surprisingly elevated rates we saw a year ago, and it will be good fortune if the UK can keep the economy growing at just 1 per cent.
We all understand that the state of the economy at the moment is overshadowed by other news but we should not forget that a deterioration in the economy is highly likely to be exacerbated by the Brexit process starting now. The government and opposition seem as clueless and unprepared today about a coherent strategy for the UK as at any time since the Brexit referendum was held. The government has gone mercifully quiet with its “Brexit means Brexit” mantra, only for a new meaningless phrase about “Brexit for the many, not the few” to come from the lips of the opposition. Between them, our political leaders seem intent on a wrecking mission.