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The oil price just keeps ticking down.
Oil fell back below $60 a barrel as Saudi Arabia said it would maintain current levels of supply through November, despite fears that oil cartel Opec may slash production in an attempt to prop up prices at current levels.
Here at MoneyWeek, we are still comfortable with the idea that oil is in a long-term bull market. Even current price levels seemed unthinkably high to most commentators at the start of this year.
But the sharp drop-off has been getting the interest rate doves excited. They are hoping that with oil prices slipping, the Bank of England may be able to hold off on raising rates next month.
They’re forgetting that oil is not the only source of inflationary pressure…
Those hoping for a cut in interest rates got very excited earlier in the week, when statistics showed that last month the annual rate of producer price inflation (inflation in manufacturers’ prices, basically) had its biggest fall since records began. The sharp drop-off in the oil price was behind the fall.
Many expect a similar drop-off in consumer price inflation when September’s statistics are announced. But BoE governor Mervyn King has warned that oil prices are not the only thing to worry about. “The anticipated fall in inflation may not persist for long… a change in oil prices does not in itself tell us where overall inflation is headed in the medium term.”
He’s right to be cautious. Oil prices have been so high for so long, that so-called ‘second-round’ inflation effects are starting to rear their ugly heads.
In recent months, shop prices have been rising consistently, after years of price deflation. Retailers are sounding far more hawkish on prices as their margins are squeezed by minimum wage hikes, higher taxes and soaring energy and transport costs – not to mention the increasing success of manufacturers in offsetting their own rising raw material costs in the form of higher prices.
This threat was specifically highlighted by Mr King in his speech – a poll by the Bank apparently suggests that half of firms intend to hike prices in the coming months. This is a real concern for the Bank. High oil prices are one thing – but once retailers get it into their heads that the public will bear higher prices, it becomes much more difficult to keep a lid on inflation.
And ironically, falling oil prices might actually give retailers more confidence to press ahead with price hikes. Not only will their own transport bills fall, but so will those of their customers. A tenner less at the petrol pump is a tenner that could be spent at the till. Why, thinks the retailer, they probably won’t even notice.
So Mr King is right to target the sector in his speech. There are few things retailers hate more than interest rate hikes, as they effectively take money out of consumers’ pockets.
But then there’s the other big worry – wage inflation. This has so far been held down seemingly by immigration, particularly from the EU, and by older people re-entering the workforce (see? There’s a reason that the Government is trying to ensure that no one saves for their retirement – for more on this, see: What financial and sex education have in common).
However, a recent survey from the Recruitment and Employment Confederation found that wage inflation is picking up, and is now at a five-year high. This is the kind of statistic to strike fear into the heart of any central banker. As we’ve discussed many a time here, higher wages cut into profits, which means companies put prices up, which means people demand higher wages, and so on, leading to a vicious spiral of wage-price inflation.
So Mr King’s being pretty clever really with this speech. He’s trying to warn us all that the Bank still has the big interest rate stick, and it’s not afraid to use it if we don’t all behave.
Unfortunately, as my colleague Cris Sholto Heaton pointed out last week (Why the Bank of England should have raised interest rates) the Bank has already lost some credibility after last year’s ill-advised August rate cut – which was one of the primary reasons that the housing bubble has managed to re-inflate this year, despite Mr King’s constant attempts to talk the market down.
And so we doubt that words alone will suffice to keep a lid on inflation pressures – it’ll take action. And as markets still see November’s rate hike as pretty much a done deal, we reckon rates will have to go above 5% before the Bank’s message really starts to hit home.
Turning to the markets…
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The FTSE 100 closed at a 5-month high of 6,072 yesterday – a 42-point gain – as stocks were boosted by the lower oil price, M&A activity and strength in the mining sector. Man Group topped the leader board, its share price climbing over 8% following reports that Goldman Sachs could bid for the hedge fund. For a full market report, see: London market close
Across the Channel, stocks continued their five day rally. The Paris CAC-40 ended the day 12 points higher at 5,309, whilst the German DAX-30 closed 23 points higher at 6,117.
Stocks were also higher on Wall Street as the price of crude sank to an eight-month low. The Dow Jones closed 9 points higher at 11,867, its fourth record close in a fortnight. The Nasdaq was 3 points higher at 2,315. And the S&P 500 was also 3 points higher, closing at 1,353.
In Asia, the Nikkei closed 76 points lower, at 16,400.
The price of crude oil continued to tumble this morning, down 23c to $58.29. Brent spot was also back below the $60 mark, at $58.33.
Spot gold last traded at $571.30 in the early hours.
And in London this morning, J Sainsbury, Britain’s third-largest supermarket, reported its biggest sales increase in four years. Price cutting and a successful promotion involving TV chef Jamie Oliver helped the grocer to a 6.6% increase in second-quarter revenue (excluding fuel). However, shares were down by as much as 0.8% this morning.
And our two recommended articles for today…
The US housing bubble: which dominoes will fall next?
– The US housing bubble created jobs and a ‘wealth effect’ that has underpinned consumer spending. And consumer spending has supported the US economy for some time now. But, one by one, these dominoes are falling.To find out which have already gone, and which are at the tipping point, read: The US housing bubble: which dominoes will fall next?
Why stock market upside won’t last
– The Dow Jones may have hit an all-time high in the last week, but the indicators that really matter depict a grimmer outlook for the markets say John Robson and Andrew Selsby at RH Asset Management. What warning signs should you look out for? If you want to know how soon the downturn is likely to occur – plus how to prepare – see: Why stock market upside won’t last