UK Inflation Outlook

4th January 2010 by Shaun Richards

Happy New Year to everyone and the passage of another year makes me think about the outlook for the UK economy over this year and indeed the next one or two. In particular I feel that there are issues and concerns over the inflation outlook. Let us just take a moment to consider where we are at present. We have had a sharp reverse in Gross Domestic Product (GDP) over the past 18 months or so. Conventional economic theory would suggest that inflation should be virtually zero or even negative. Instead the Consumer Price Index (CPI) was last measured at 1.9% which is just below the targeted level of 2%. There are good reasons to suggest that it will rise over the next few months as we head into spring/summer of 2010.

One issue that has concerned me is the way that prices are operated these days. I have written on this subject before. My premise is that modern pricing systems are very opaque and hard to compare between suppliers. I also feel that the growth of the supermarket system in the UK combined with the small number of large players has led to a fragmented pricing system developing in an area which accounts for a lot of consumption in the UK. I am surprised how rarely the subject of this large market being in effect an oligopoly is raised. Simply going to my local supermarket has led to various inconsistencies which I have listed before. For example a 142 gram tin of Garden Peas being more expensive than a 300 gram tin. The fluctuation in the price of bread which is certainly week by week. This week there were two more examples. One is the relative staple of own brand porridge oats (very nice in the current cold weather in my view), where a 500 gram bag costs 42 pence and a one kilogram bag costs 99 pence. Another example is the brand of English Breakfast Tea I buy which is currently £1.70 for 50 tea bags but £3.99 for 100 tea bags. How many people are paying the “wrong” price? As this particular supermarket has a system where it can track all purchases made by its cardholders and it rewards you for having their loyalty card, this pricing structure is likely to be well-informed. So I can only conclude that it gets a double reward as follows. It can claim low prices whilst having customers who pay the higher ones! How very convenient for them. But it is in effect a failure of the market system and by definition causes higher prices to be paid.

Anybody who has compared utility prices or mobile phone tariffs in the UK will also have discovered that the main players all try as hard as possible to stop you comparing prices on a like for like basis. Again a failure of the market system. Actually it is also a failure of the regulatory system. So again I suspect that many people are paying higher prices than they should.

Overall I think that these effects have led to the pricing system of the UK being less efficient than it should and by contributing to higher prices has also led to inflation. This is not a good combination.

Another issue is the structure and systems set in place for many public sector prices. For example Postcomm (The regulator of the postal system) has set in store a system which restricts stamp prices in the UK and is based on an inflation index. However as this particular index has fallen it has let the Royal Mail off this ruling for this year. How nice of it! The Royal Mail is publicising the fact that it is not increasing stamp prices as much as it could. Whilst you muse on the idea of a rule which only operates when it suits you and is abandoned when it does not please also think what stamp prices were in the summer of 2005. The answer is a first class stamp was 30 pence in the shops and a second class stamp was 21 pence. As of the 6th April 2010 they will be 41 pence (a rise of 36.7%) and 32 pence (a rise of 52.4%). Now this years increase will be 5.1% for a first class stamp and 6.7% for a second class stamp and is being imposed in a severe recession! If we move onto transport there was a lot of publicity from the rail companies that regulated fares would only rise by 1.1% this year. However as time as gone by there has been a lot of examples of unregulated fares being increased by considerably more. In London many people who use the buses and underground use the Oystercard system, however the price of a bus journey has gone from £1 to £1.20 and a zone one tube journey has gone from £1.60 to £1.80. Again in a recession!

So there are structural reasons why inflation has persisted. There are also economic ones.

1. The effective exchange rate index of the £ fell from 105.39 at the end of January 2007 to 79.40 at the end of November 2009.

2. Monetary policy has been very expansionary with the Bank of England’s base rate being only 0.5% and with its Quantitative Easing (QE) programme well on its way to buying £200,000 million of assets.

3. Fiscal policy is also very expansionary with the budget deficit being expected by the Treasury to be some £178,000 million this fiscal year.

Going Forward into 2010/11

It will be a while I believe before factors 2 and 3 are reduced or reversed. We are likely to have to wait for the upcoming election which is likely to be in May 2010 to get a clearer idea of future policy. There is some who feel that the QE programme will and indeed should be increased. I am not one of them. The pound has stabilised and has risen from its lows so it may be a small depressing influence on prices.

There is currently a factor which is in the process of raising prices and hence inflation is the fact that the main rate of VAT is returning to 17.5% from its one-year reduction to 15%. There is also the addition boost from the way that this was implemented by the Chancellor of the Exchequer. Having raised excise duty on fuel,tobacco and alcohol in 2009 when VAT was temporarily cut he has not reduced the excise duties when returning VAT to its normal level. This may led the Governor of the Bank of England to write to him if CPI inflation rises above 3% which is not certain but is certainly possible. It could be a short letter i.e ” a major influence was your own actions sir!”

As we start the year the oil price has recovered to around $80 and many commodity prices are rising too. I am not one of those who sees inflation around every corner and am also aware the oil prices can fall as well as rise. Predictions are notoriously unreliable in this area. But with our inflation level already surprisingly high there are dangers on the upside for 2010.

Leave a Reply

Your email address will not be published. Required fields are marked *