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Auguries for a 'vile' decade Samuel Brittan Financial Times 23/05/08 It sometimes pays to look beyond the headline statistics. The increase in the UK annual inflation rate, measured by the consumer price index, from 2.5 per cent in March to 3 per cent in April - way above the official 2 per cent target - caused quite a stir and a spate of pessimistic comment about the prospects of bank rate reductions. One's first instinct is to make a comparison with a year ago. This serves as a reminder that inflation on this measure was just as high then. To be precise, it was actually higher, at 3.1 per cent, in March 2007 and triggered the first statutory letter of explanation from the governor of the Bank of England to the chancellor of the exchequer. But this proved to be a flash in the pan, for the inflation rate then started falling rather quickly to reach a low of 1.8 per cent last August. Yet history rarely repeats itself exactly. The Bank expects inflation to peak at about 3.7 per cent this autumn. This may not prove to be the exact number, but there is no reason to disbelieve the Bank on the direction of movement. Meanwhile it is instructive to look not just at rates of increase, but at the CPI itself. The Office for National Statistics has kindly provided a breakdown of the increase between April 2007 and April 2008. By far the biggest contribution came from transport, which accounted for 0.93 percentage points of the CPI's rise to 3 per cent. This is hardly surprising when petrol and oil costs rose by a cool 18 per cent over the 12-month period. The second biggest contribution came from food and non-alcoholic beverages. The third was "housing and household service", reflecting past mortgage rate increases. Fourth came "restaurants and hotels", influenced by all the foregoing. Most other categories made very small contributions or, like clothing and footwear, fell in price. The general moral is that, so far at least, inflation does not reflect anything like the old familiar wage price spiral but higher prices of products that are either imported or at least sold on organised international markets. This is obviously a global problem and not just a UK one. John Lipsky, first deputy managing director of the International Monetary Fund, has just reminded us that global consumer price inflation is now running at nearly 5.5 per cent, compared with less than 4 per cent in recent years. He asks whether the increase in energy and commodity prices represents a durable shift. In that case, western consumers will just have to get used to paying relatively higher prices for these items. The task of governments and central banks is to make sure that we take these pressures on the chin and do not try to inflate out of them. Mr Lipsky raises the question of whether these primary prices will keep on rising more rapidly than other items or whether we are facing a once-for-all shift. He hopes that it is the latter, but he is not fully convincing. He himself points out the demand for commodities has remained robust on account of strong growth in developing countries led by China and India. Of course the terms of trade will not for ever move against western consumers, any more than they moved for ever for them in earlier postwar decades, as wrongly predicted by one school of development economists. Nevertheless present trends can go on for quite a long time. Indeed reality may prove even more complicated. We could see a temporary reversal of primary price trends due to the current slowdown in western economies, followed by a renewed rise in such prices as "recovery" takes place. Some such short-term slowdown can be detected in metal prices. But there is no such respite in oil prices, which continue to break fresh records for all US president George W. Bush's jaw-boning to the Saudi Arabians. One thing is for sure. This is that the partial relief from inflationary pressures provided by cheap manufactures from China is over for a long time. And to the extent that China allows the renminbi to appreciate, the more expensive its exports will become. Michael Saunders, the Citigroup analyst, warns that the "nice" decade of Mervyn King, governor of the Bank of England, is likely to be followed by a "vile" one - volatile inflation, less expansionary. This applies not just to the UK, for which it was coined, but the old industrial west as a whole. Food and energy account for 15-20 per cent of the typical Organisation for Economic Co-operation and Development family expenditure. This may not seem enormous, but cost increases here, concentrated in a brief period, can make quite a dent in living standards. Indeed the inflationary or deflationary aspects are the least important in a changing world economy. No monetary policy can halt the changes in relative prices that are radically altering the balance of world real income. The Economist sterling commodity price index shows a near 160 per cent rise since the beginning of this decade. IMF indices show a 20 per cent improvement in the terms of trade of "developing and emerging countries". But this is a hold-all category, covering everything from the energy producers that have had a bonanza to some of the poor food-importing countries that have suffered a further blow. It is not how a just God would have redistributed economic opportunities.
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