Early in 2008 when interest rates were too high for comfort and likely to help bring more banks down, I called for much lower rates. At the time I said inflation would tumble anyway, as the inevitable recession bit.
As expected the recession came, and inflation has fallen sharply on the RPI measure, less so on the CPI measure. It is time to reassess the inflationary outlook, as interest rates have now be held well below normal recession levels for some months , and quantitative easing is well underway.
UK inflation has proved to be more obstinate on the CPI measure than the deep recession would suggest, for three main reasons. The first is the collapse of the pound in 2008. As I warned at the time, a money policy which lurched to being too easy would drive the pound down, which would leave us very exposed to imported inflation. We are now living with the consequences. Forward currency cover is running out for importers. Stocks of cheaper imports are running out. New product is costing more.
The second reason is the commodity price revival, brought on by Chinese restocking and probably by speculative activity on the back of quantitative easing, Oil has more than doubled from its bottom levels earlier this year. Although sterling in recent weeks has been getting stronger, abating the import price issues, commodity prices have been going up more quickly than the currency, leaving more price pressures in the system.
The third reason is the behaviour of some industrial companies. Usually in recession as volumes fall away companies offer price cuts to try to induce more spending on their goods, or at least to encourage gains of market share. This time round the volume reductions have been so enormous – a halving of demand is typical in the automotive areas for example – that some companies are taking a different view on price. They are saying to their customers our overheads per unit of output have risen sharply, thanks to the big drop in your orders. As a result we cannot afford to offer you any price cuts. In some cases they may even propose price increases, to try to reduce the losses on the limited output they can sell.
In both the US and the UK industrial work forces are on the whole co-operating with management to combat the huge falls in demand. In many cases employees have volunteered for more short time working, extended factory holidays and the like to cut both output and their pay in the hope that will enable them to keep their jobs for the upturn. In other cases Unions and employees have reluctantly accepted the need for substantial redundancies and factory closures, as companies desperately try to cut their costs and output as demand plunges.
Employees seem to understand that the banks are not prepared to pay for ballooning stock and work in progress that cannot be sold, and not prepared to pay for large losses in industrial customer companies. They have their own losses to finance instead. Companies have to run down their stocks of raw materials and finished goods, and have to cut employee costs. Most companies embarking on such reductions are also cutting out management jobs as well. Where the cuts are made by short time working, managers may also have to go onto shorter weeks for less pay.
UK inflation will be higher than it should be owing to monetary and fiscal looseness, the commodity surge and the weakness of the pound last year. The authorities must not ignore inflation. It is down for the moment, but not necessarily out.