There’s no doubt about it – inflation is going global.
Despite the authorities’ best efforts, China’s banks are still lending like mad. Food prices are rocketing. Oil is now widely expected to hit $100 a barrel again – it’s just a matter of time.
Most pundits in the papers are advising that the Bank of England do nothing about all this. And to be fair, the arguments for keeping interest rates where they are have a lot of merit.
But that doesn’t mean that rising inflation won’t have any ill-effects…
Why companies can’t expect cheap goods from China anymore
There was an interesting piece in yesterday’s New York Times, all about how companies can’t expect to source cheap goods from China anymore.
Wholesalers attending next month’s trade shows are “going to go home with 35% less product than for the same dollars as last year”, comments Bennett Model, chief executive of a US designer clothing line. “The consumer will definitely see the price rise.”
We know that raw material prices are rising, and that wages in China are rising too. But what’s most fascinating about the piece is this: Model reckons that US companies are now having to compete with China’s domestic retailers. “The American wholesaler will fight [a manufacturer] on $5. The domestic retailer doesn’t care as much.”
This idea – that Chinese manufacturers are dismissing penny-pinching foreigners in favour of less price-sensitive domestic ones – starts to turn everything we ‘knew’ about the last decade on its head. On the one hand, it’d be great news if the Chinese started consuming more of their own goods. It’d be a sign of the ‘global rebalancing’ that we’re all desperately searching for. But it also means a lot more pressure on prices for the rest of us.
UK producer price figures this morning, for example, were well above expectations. Input prices for December were up by 3.4% on the previous month, well above the 1.5% expected.
What can the Bank of England do about it?
As many of you have correctly noted, the UK’s bank rate (what we all used to call ‘base’ rate) has absolutely no impact on the global price of oil. The only potential way it can affect import prices is by raising the value of the pound – and there’s no guarantee that would happen.
So what use could raising rates be? The main impact is to control expectations. If consumers see higher prices, then they expect inflation to rise, and the danger is that they demand higher wages to match. As a result, you get companies raising prices to pay higher wages, and the two things feed off each other in an inflationary spiral.
Most pundits reckon this is unlikely to happen. There are too many unemployed people and the economy is too fragile. And while there are some arguments against this (our Roundtable experts recently seemed to think that the manufacturing sector had very little, if any, spare capacity), there’s no real sign of wage pressure rising yet.
So chances are – as my colleague Merryn Somerset Webb has pointed out on her blog – that the only thing that’ll get the Bank moving is evidence that wages are rising more rapidly than inflation.
But of course, even if rates stay low, inflation still extracts a large cost from the economy. Someone has to pay for those price rises. My own personal inflation gauge – the speed at which the price dial on the petrol pump overtakes the volume dial – has shot up, for example.
Retailers can also expect a tough time. If they try to pass on their costs along with the VAT hike, people will shop elsewhere. If they don’t pass on their costs, they’ll end up with lower margins. It’s hard to see how 2011 can be a good year for them. Disappointing margins tend to mean lower share prices too.
So what could bring down the cost of raw materials?
Realistically, the one thing that everyone is afraid of – a huge slowdown in China. The more inflation spins out of control over there, the more likely the country is to have to slam on the brakes, and the more likely that becomes.
The threat of a Chinese slump is on almost everyone’s worry list for 2011. And yes, it would be bad news for commodity producers and to an extent, oil companies, not to mention all the companies who have been gearing up their expansion to that side of the world. But a dive in raw material prices would certainly help with Britain’s inflation problem. It may sound odd, but in some ways, a slowdown in China’s growth could be just what the rest of us need.
Our recommended article for today
Three ways to protect your wealth from 1970s-style stagflation
The forces at work that paved the way for stagflation in the late 1960s and 1970s have very clear parallels today, says Matthew Lynn. Here’s how to prepare yourself.