THE other day I was looking for a shed for the garden. I say shed but what I
had in mind was a palatial wooden building complete with double glazing and
power supply for moments of contemplation.
Anyway, the point is that the salesman told me that I should get my order in
quickly because the prices were about to go up by 10%. Being a canny kind of
guy, especially when it comes to sheds, I checked. Sure enough, he was not
spinning me a line.
Now this, to connoisseurs of the game played out daily between firms and
customers, was quite unusual. As far as “things” are concerned — and I
exclude houses from this — we have become used to prices coming down, not
rising. As long as you don’t blink too soon, retailers will come down to
your level.
Or so it seemed. Now it appears the game is changing. Buying ahead of price
rises (I have not made my mind up on that shed) was something we used to do
in the days of high inflation. For years now firms have faced extreme
resistance from customers to higher prices; they have lacked pricing power.
But things appear to be changing. You could say, and I apologise in advance
for this, that firms are shedding their inhibitions.
The CBI says that manufacturers’ price expectations are at their highest since
1995. For consumer products they are at their highest since 1990.
There is a possibility that this may be overstating it, given that
manufacturers have been under the cosh until recently but are now enjoying
better times. But the Institute of Directors, in a survey covering business
in general, says price expectations are at their highest for 11 years.
Why might this be? Economists, including those at the Bank of England, have
long been looking for so-called second-round effects from the rise in oil
prices over the past four years, which has resumed in recent days with the
tensions over Iran. Mostly, those effects were expected to come through
higher pay settlements, but that danger seems to have passed, for now at
least.
Instead, the main second-round effect appears to be through the return of
pricing power and, to be fair to the Bank, it did warn of the danger of this
about a year ago. Put simply, it is easier for firms to force through price
rises if they have something to blame it on, in this case dearer energy.
How worried should we be? Ian McCafferty, the CBI’s chief economic adviser,
says we should be cautious about reading too much into the
price-expectations data. In the past, the fact that a net 21% of firms (38%
for consumer goods) plan to raise prices over the next three months might
have been associated with double-digit inflation. Now it is likely to be
associated with much more modest rises. Even so, that is in contrast to the
falling goods prices we have been used to.
There is another important factor. Shop spending, which remains strong (though
some retailers are suffering pain) is defying gravity. Official figures last
week showed that real household disposable incomes last year were just 1.3%
up on 2005, and that incomes in the fourth quarter were no higher than a
year earlier. You have to go back a quarter of a century for figures as weak
as this. Retail price inflation, at a 15-year high of 4.6%, is easily
outstripping the rise in average earnings.
These are the ingredients, not just for a sharp slowdown in consumer spending,
but for extreme buyer resistance to higher prices. Firms may try it on, in
other words, but may end up with egg on their face. Next has a mid-season
sale this weekend; Debenhams seems to have one most weeks.
The question for the Bank is whether it can afford to take a risk on consumer
resistance. Several of the members of its monetary policy committee (MPC),
who gave evidence to the House of Commons last week, are worried about the
return of pricing power, and may be itching to fire another warning shot
across the bows of firms planning to raise their prices.
We are back in the situation of January when the City expected a further hike
in interest rates but did not expect it to happen straight away. Then, the
markets thought the MPC would wait until February and the inflation report.
Now, with rather less confidence, analysts expect the Bank to hold fire this
week but raise to 5.5% in May.
Why wait? The “shadow” MPC, which meets under the auspices of the Institute of
Economic Affairs, sees no reason to do so. Its “vote”, ahead of the MPC
meeting this Wednesday and Thursday, is 8-1 for an immediate rise. Two of
its members think the hike should be by half a percentage point.
There are three significant things about the shadow MPC’s verdict. It sees the
financial-market turbulence of a month ago as having passed, giving no
reason for the Bank to delay. Its 8-1 vote is the mirror image of the actual
MPC’s vote to leave the Bank rate on hold at its March meeting. And, as I
have been pointing out, the shadow MPC’s predictive record has been very
good; it anticipated each of the last three rate rises, including the
surprises in January and last August.
Is there any reason to bet against the shadow MPC this time? Two members of
the actual MPC, deputy governor Rachel Lomax and external member David
Blanchflower, are unlikely to vote for a rise because of worries about the
American economy and the sub-prime mortgage market. That, incidentally, is
why one of the “shadows”, Patrick Minford, favours a cut rather than a rise.
How will the other seven on the Bank committee vote? I can see Charlie Bean,
its chief economist, preferring to wait for a new forecast. I can also see
three committee members, the new “hawks” Andrew Sentance and Tim Besley,
together with John Gieve, the other deputy governor, seeing no reason to
delay.
That would leave Mervyn King, Paul Tucker and Kate Barker as potential “swing”
voters. Which way will they swing? Hard to say.
I would be inclined to wait until May but I’m also reluctant to bet against
the shadow MPC. The chance of a rate rise this week has to be close to 50-50.
PS: Another bad set of balance-of-payments figures has once again
raised the question — why don’t they seem to matter any more? Last year’s
deficit is put at £43.4 billion, 3.4% of gross domestic product, up from
£29.2 billion (2.4%) in 2005. The deficit in goods was a whopping £83.7
billion.
In cash terms all these numbers easily set new records, though as a
proportion of GDP the current account was higher in the mid1970s (4%) and
late 1980s (5.1%). But the question remains: why didn’t the latest figures
provoke a good old-fashioned sterling crisis?
My usual answer is that what used to happen was that trade flows dominated
capital movements, so a big trade deficit automatically put downward
pressure on the pound, and upward pressure on interest rates. Now even big
trade and current account gaps don’t matter as long as Britain continues to
attract capital.
There is an additional answer, however, provided by Jim Tomlinson of the
University of Dundee in a paper to the Economic History Society’s annual
conference in Exeter this weekend. He points out that the balance of
payments dominated the economic news from the 1940s to the 1970s, even
though the current account was more usually in surplus than in deficit.
Despite this, the reason we appeared to lurch from one balance-of-payments
crisis to another was, as Tomlinson argues, because the bar was set so high.
The aim of policy was to run a large current-account surplus to pay for UK
overseas investment and military spending abroad. When we fell short of
these high expectations, the impression the public got was one of failure.
We may have beaten ourselves up unnecessarily, leading to a national
inferiority complex, when the underlying picture was not that bad. After
all, it took until 1982 before Britain ran a trade deficit in manufactured
goods. The problem in that era was one of Britain’s overblown, end-of-empire
ambitions. The problem now is that we just have a chronic deficit.
david.smith@sunday-times.co.uk
