For the last decade no one has given inflation a second thought. Prices have looked relatively stable for as long as much of the population can remember and there’s been no expectation of any change. No more. The newspapers are full of stories of 40% jumps in cauliflower prices and families unable to come up with the £90 they need to fill up for the school run, while only last week the IMF warned that in Britain inflation is such a severe threat there will be no scope for interest-rate cuts for some time.
Now, the IMF isn’t the best forecaster in the business, but this time at least it is worrying about the right thing. British producers face input inflation at 28-year highs and our Consumer Price Index (CPI) at 3% is far higher than most would have forecast only a few months ago.
And it isn’t just us. Eurozone CPI is at a 16-year high of 3.6%, with producer price inflation running at 6%. In America, Federal Reserve chairman Ben Bernanke has been fretting about high headline inflation (which includes food and energy costs and is now running at 3.9%) pushing up inflation expectations and then inflation itself.
Worse, this inflation is no longer confined to fuel and food prices. Instead, as Tim Bond of Barclays Capital puts it, it has become “virtually ubiquitous”. Recent British data showed that goods and services inflation is accelerating sharply (those in doubt should try taking a trip to the dentist) and both here and in America businesses seem confident they can raise prices. A recent survey in America showed a “sharp increase in the balance of respondents intending to increase their selling prices”.
Readings like this haven’t been seen since 1981, says Bond. Normally in recessionary times businesses have little confidence in their ability to make price rises stick, so it is particularly worrying that the same kind of murmurings are coming from British businesses. UK retailers can’t “absorb these costs… for ever”, said a spokesman for the British Retail Consortium last week, around the same time as the National Farmers Union was pointing out that rising production costs have yet to make their way into shop prices.
So what’s pushing prices up? The most obvious answer is commodity prices, which have risen massively over the last few years and will probably continue to do so over the medium term. There’s been much debate in the last month about the extent to which prices have either been driven by speculation or are reacting to fundamental drivers. George Soros says it is all about speculation and that prices will soon fall back. Others says the actual impact of speculation is tiny – “a chip in the woodpile”, as one big American investor put it this week. But how much recent price moves may have been driven by hedge funds and futures buying is by the by in that it makes no real difference to the underlying case for the commodities supercycle.
Take agriculture. Grain prices had a huge spike earlier this year and have fallen back since. But ignore the volatility and it seems clear that they’ll still end this year higher than last and next year higher than this year. Why? All sorts of reasons, including rising oil and fertiliser prices; growing consumption in the East; a growing global population; productivity-dampening protectionism in the West; water supply problems all over the place; and, of course, the bonkers biofuels policies the Americans and Europeans refuse to give up.
The same sort of thing can be said for most energy-related and hard commodities. Yes, they may have risen too far too fast in the last few months, but the tight supply-and-demand fundamentals remain as they were. It’s coming with blips, but the supercycle isn’t anywhere near over yet: “we are”, as Jeffrey Sachs says in Fortune, “running up against serious resource and ecological limits”, which, given the size of the global population (two billion more than 30 years ago), bind us even more tightly than they did in the 1970s.
Next, we need to look to inflation levels in the developing world. Think you’ve got it hard at 3%? Spare a thought for the Russians (12%), Vietnamese (21.4%), Hungarians (9%), Chinese (8.5%), Egyptians (16%), Bulgarians (16%), Ukrainians (29%) and the Argentinians (officially 8.5%, but probably 20% plus).
Why is this happening? Partly because of commodity price shocks, of course, but also, says Joachim Fels of Morgan Stanley in The Daily Telegraph, because of easy money. “Weighted global interest rates are 4.3%, while global inflation is above 5%”, largely due to the fast falls in American interest rates since September last year. In aggregate, “the real policy rate in the world is negative”, something that means that the world’s central banks (and the Fed with its frantic rate cutting in particular) are “both fuelling and accommodating the rise in food and energy prices”.
This is not an easily resolvable situation. As long as so many currencies remain in one way and another pegged to the US dollar, and hence to American monetary policy, there isn’t really much emerging economies can do. They could unpeg their currencies, but, as Stephen King notes in The Independent, this didn’t work for Japan in the late 1980s: the end result was temporarily-suppressed – not defeated – inflation. That leaves emerging-market economies with one “simple strategy… it’s called ‘hope and pray’” – and it doesn’t very often work.
All this matters for us – partly because during the last decade’s long years of national delusion the main thing keeping prices down has been the low cost of imports from developing markets. But if prices are rising there (note wages were rising at an annual rate of more than 20% in China last year), so is the price of those imports.
This is compounded for us by the ongoing collapse in the pound and for America by the weak dollar (import prices in the US rose at an annual rate of more than 15% in April). It also matters because loose monetary policy – and economic strength combined with fast-rising wages across Asia – means there is even less reason to think food and fuel prices are coming down soon.
The point I’m trying to make here is that our inflation rate in Britain isn’t just about us. It’s a global thing and that makes it very hard to deal with. We can’t do anything about US monetary policy and we can’t do anything about wage rises in China. We can’t do anything about fuel or food inflation, certainly not in the short term anyway. Inflation could perhaps be tamed by sharp rises in real global interest rates. But that isn’t looking likely: so far, as Tim Bond points out, the global policy reaction has been “supine, consisting of little more than hot air”.
Will this change? In the face of collapsing house prices, economic slowdown and pressure for stimulus, will the ECB, the Bank of England and the Fed all start to raise interest rates? I can’t see it myself.
So how bad will it get? Hard to know, given the economic uncertainties. But one thing that should make us all worry is the data on inflation expectations. In the last couple of quarters, the percentage of American and British consumers who expect inflation to average 5% or more has soared 25%. These are the highest readings since the early 1980s, which should focus the mind on wage push inflation.
James Ferguson thinks this isn’t a risk (see Stagnation, yes – inflation? I don’t think so). I’m not so sure. Listen to Radio 4 in the morning and more often than not you’ll find a story that involves the unions “working with” some organisation or other to raise the total packages of a group of employees. This week they were working to bump up car allowances for nurses.
They’ve also recently been working with local council employees to get above-inflation settlements. They failed, but GMB union national secretary Brian Strutton isn’t giving up. “Our members are sick of pay rises that do not match the cost of living. I do not believe that GMB members will stomach another paltry offer when we open new pay negotiations later this year.”
Bravado? Maybe, but consider the fact that last year more than one million days were lost to industrial action in Britain for the second time in a decade and it’s not something I’d be complacent about. Right now, it seems to me all portfolios should be positioned for both inflation and recession. See Four ways to beat inflation for some ideas on how this might be done.