Inflationary times?

The Governor’s speech at the Mansion House last night showed more realism about the situation, stressing the way individuals and families were going to be squeezed by the current economic policy. He did not, of course, venture a criticism of the government for refusing to squeeze the waste in the public sector to take some of the strain, did not make a case for a stronger Bank, and decided to threaten higher interest rates if people did not behave as if the Credit Crunch had never occurred. Apparently the government has now realised it got the changes to the Bank fo England wrong and wants to strengthen the Bank’s role in money markets and bank supervision.

I know many of my readers think UK inflation is a much more serious problem than I do, and think the Governor is right to menace us with further tightening if necessary. My case has been throughout that we will have a difficult time with inflation for much of this year, as the high commodity prices work their way through the system. That will simply cut real incomes by more, and lead to further reductions in output and a greater slowdown in the economy as a whole. Inflation will then subside, as it will not follow through into higher wages. There will be no 1970s style inflationary spiral. The collapse of inflation could even happen more quickly if it turns out there is a lot of speculative money in commodities which suddenly departs – as we saw when the gold price hit $1000 an ounce.

Readers could point out this morning that the tanker driver wage settlement, at 15% over two years, has broken out from the low single figure settlements we are used to. If this were to become a new benchmark for aggressive negotiators, and if other employers are about to concede such settlements, you would be right, and inflation will be out of control. Clearly Chancellor and Governor are worried sick about the prospect of wages taking off, as it would cause that foolish chase of differentials and money around the system which simply undermines the spending power of the pounds you seek to earn.

I am sticking with my original view despite the tanker drivers, as I think for the moment they are a special case. Any group of workers tied into the bonanza of energy and commodity prices have a chance to raise their relative position in the wages pecking order thanks to the boom conditions in their markets. Conversely, if you are in property, finance, building and construction you will be relieved merely to keep a job and will not have similar power to raise your wages. My theory can accommodate a few outrider settlements in hot areas of a rapidly cooling economy, but would be wrong if this turns out to be a more general problem. So far there is every sign the government is holding the line on public sector pay, where cost overruns in previous years have been so large. There is still discipline in most of the internationally traded activities despite the take off in Asian inflation.

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11 Comments

  1. Tony Makara
    Posted June 19, 2008 at 11:13 am | Permalink

    With food inflation rising all the time, due in large part to the Pound falling against the Euro, something most commentators seem to have overlooked. We can now expect to see real strains on the cost of living. This will be most telling in the public sector and the potential for conflict is enormous. Labour foolishly created a large public sector but that could well prove to be their undoing if refusal to meet pay claims leads to government employees bringing the country to a halt. The union bosses sense that they have government on the run over inflation and wages and it will be no surprise if they start to set the agenda. I see no sign of food and fuel prices falling in the immediate future and this will mean increased pay demands.

  2. Cliff
    Posted June 19, 2008 at 12:26 pm | Permalink

    John:

    I am but a simple man and certainly not an economist. Are you able to answer a question that is bothering me?
    We were told yesterday that, the BoE monetary policy committee considered raising interest rates in order to help curb inflation.
    It has been stated all over the media and on many blogs that the rise in inflation is down to rising global oil prices and rising global food prices.
    I cannot understand how, raising interest rates in the UK will have any effect on world oil or food prices.
    Perhaps you could explain to me and I suspect many of your readers, just how raising interest rates in the UK will bring down world oil and fuel prices.

    Reply: It cuts demand in the UK, diverting money into paying interest and reducing the amount of money available to borrow. It will have only a very small effect on oil and food demand and therefore on world prices.

  3. Acorn
    Posted June 19, 2008 at 1:26 pm | Permalink

    Don’t have too much sympathy for tanker drivers. On my patch, close to a refinery rack depot, we know that fuel tanker drivers are the best paid. Even better that the refinery workers, who have the highest GVA per pound of salary of anyone in the country outside of the City. They were in the seventies –when they were directly employed by the refinery – and still are even after being outsourced. £800 a week with overtime; and, don’t dare suggest employing more drivers to reduce the overtime! Tanker drivers and general haulage drivers are two different worlds.

    It is all starting to sound like the seventies again. I think I need to brush up on such things as “the winter of discontent”; “the social compact” and “this will not affect the pound in your pocket”. Nations are much more tightly connected economically than they were in the seventies. Home grown wage push inflation, will kick us out of the game much faster than it did back then. But, the big problem is the public sector.

    The last time Prof David B Smith calculated the size of the “non-socialised economy” [2006]; he reckoned the state was spending 48.75% of the GDP. That is, about 95.25 pence for every pound spent by the private sector, (based on non-oil, market price GDP). It will take a decade at least to rectify this problem, that is, if we could find anyone – assuming he does not have four stars on his collar – to fix it. I am not holding out much hope. But, we can’t say we weren’t told; every period of socialist government ends with the nation a busted flush.

  4. adam
    Posted June 19, 2008 at 2:04 pm | Permalink

    It was an amazing thing to say that pay increases cause inflation and trying to influence the private sector.
    With ppp corruption the government has more influence than ever.

    The government doesnt create inflation by spending money. Darling knows that full well, so why lie. Why do our politicians hate the people so much.
    Will Nuliars be getting rid of their 'inflationary' minimum wage then?

    An end to the bottomless 2012 slush fund?

    no chance!

  5. Stuart Fairney
    Posted June 19, 2008 at 3:01 pm | Permalink

    This is a very good analysis and I think it is vital that the Bank of England don't drag us through the whole "1930's Montagu Norman deflationary tragi-farce" again by obsessing about a marginal inflationary threat. Higher rates now (if in fact they are effective because base rates and LIBOR don’t enjoy the close relationship they once did) would seem to me the equivalent of setting yourself on fire to stay warm. Was it the late Alan Clark who talked about the importance of not blindly applying yesterday’s analysis and solutions to today’s problems?

    As for the tanker drivers, I think they have now realised that they are a choke point for energy supplies rather like the miners did in the 1970’s I don’t think we have seen the last of this.

    You are exactly right. The level of government debt and spend is inflationary and this is the real “elephant in the room” that neither the bank, nor the government nor the good ol’ Pravda-BBC want to admit. And thus I fear it will continue.

    What price Darling scurrying off to the IMF a la Denis Healey in another 1970’s parallel?

  6. Derek
    Posted June 19, 2008 at 3:15 pm | Permalink

    It looks like the government is keen to push ahead with rate increases. Today's ONS figures suggest stronger than expected retail sales. Nobody I know, including those in the supermarket sector, would describe trading as anything other than dire. However, in food sales by volume would have to fall by more than ten percent to offset price inflation. If supermarkets have got more money ringing through their tills (unlikely in my opinion) it's driven by price inflation not consumer confidence. There are lies, damned lies and ……

    I agree with your point about only certain sectors having the ability to dictate pay increases. I would concede that (so far fingers crossed) my employees have been quiet on this front. They see the sales figures and know their positions are precarious. However, there's a minimum wage increase in the pipeline that the government is unlikely to renege on. The minimum wage is often overlooked, but I would suggest it's one of the most inflationary factors there has been and many of the current problems are a manifestation of it. Socialist fools just don't understand that you can't just proclaim everybody wealthier without ramifications. Having said that the Bush administration sent everyone tax rebates – short term gain, long term pain.

    I think we may have waved deflation, in everthing but property and second-hand cars, goodbye for quite a while. Only time will tell who's right, I actually hope it's you, but I think that's being Pollyannaish.

  7. mikestallard
    Posted June 19, 2008 at 6:38 pm | Permalink

    Let us fervently hope that you are right.
    You have not, however, mentioned the TU. The Labour Party, without Lord Levy, is now £25,000,000 in debt. Apparently the traditional membership is simply melting away. (Telegraph today).
    What a temptation, before the next election, to approach the Unions to see if they can perhaps help out financially? And, of course, there might just be something in it for them……(Newsnight last evening)
    Down here at grass roots level, people are for some reason convinced that MPs have just voted themselves a huge salary increase. Yes, I know it is a lie. But it somehow encourages people….
    I take your point about people desperately clinging to their jobs – been there and bought the T shirt – I wonder, though if that applies to all those client state public sector workers, especially if they are egged on by their Unions…..
    Food for thought here, I think.

  8. Brian Tomkinson
    Posted June 19, 2008 at 7:19 pm | Permalink

    I am one of those to whom you refer who strongly believes that inflation is the major threat to our economy and the British people. Having seen the extent of the damage done to this country by inflation in the seventies, it is distressing to hear people trying to ignore the warning signs and dangers. The government has fiddled the measure of inflation which bears no relation to the daily experience of the majority living in this country. Inflationary expectations are rising with frightening repetition. There are worrying noises from the government's paymasters in the trades unions regarding strike action, no doubt encouraged by the success of the tanker drivers in securing a massive increase in wages. Today's news that retail sales rose by 3.5% during May, the strongest monthly growth since January 1986, should show the Governor of the Bank of England that his monetary committee was mistaken in not increasing interest rates earlier this month.

  9. Posted June 19, 2008 at 11:46 pm | Permalink

    http://cityunslicker.blogspot.com/2008/06/discuss

    John, inflation will cause people to want wage rises, private sector workers on the whole will be unable to get them. However, my link above is to a debate started today on Tory tax policy.

    I think the current thinking on the front opposition bench is muddled, please can you help them to some clarity on their thinking.

    Where are the promises of spending cuts which will be needed to allow changes to the tax system. Why even with a big lead in the polls is the nettle not being grasped?

  10. Will S
    Posted June 19, 2008 at 11:47 pm | Permalink

    In the end this current inflation if a one-off and we'll have to learn to live with a little less than we used to. We've had a decade of luxury, now it's time to lower our expectations for a little while while the world sorts itself out.

  11. James
    Posted June 20, 2008 at 11:21 am | Permalink

    I often like to remind bloggers and Telegraph journalists that if inflation has been running at 10% a year for the last few years, as they often claim, then GDP has been overstated by much the same amount, and our living standards are nearer Eastern Europes or Britain's of the early 1980s than what we thought they were. This seems unlikely, to say the least.

    In response to the commenter who asked how higher UK interest rates can cut world food prices, they can't. But the point is that an increase in import costs, such as food and increasingly oil as we've pumped much of it out, is a REAL loss of living standards. We now have to send (say) 5% of our income to the middle east or Canada, and as such its not money we can spend on other goods. An interest rate rise essentially makes this happen, and so other goods will fall in price, offsetting the rise in price of oil/food.

  • About John Redwood


    John Redwood won a free place at Kent College, Canterbury, He graduated from Magdalen College Oxford, has a DPhil and is a fellow of All Souls College. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.

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