IT is not often you get a combination of low inflation and record oil prices
but that is what we have had in recent days. Not only that, but the Bank of
England’s monetary policy committee (MPC) considered cutting interest rates
earlier this month. What’s going on?
Three months ago, when inflation dipped below the government’s 2% target, many
were sceptical it would stay there. After all, it was only in the spring
that Mervyn King had been forced to write an open letter explaining why
inflation, at 3.1%, was too far above target.
Now, we have had three sub-2% figures in a row, the latest being September’s
1.8% rate. I have not heard King crowing from the Bank’s rooftops about this
– he has had other things on his mind – but it has come as welcome relief
amid his other travails.
The drop came in spite of a jump in food prices, particularly dairy products
(I’ll devote a column to food soon) and petrol prices being up on a year
ago.
Though many do not like such measures, “core” inflation, excluding food,
alcohol, energy and tobacco, dropped to 1.5% last month, its lowest for 11
months. One worry earlier in the year was that core inflation was rising.
The consumer prices index (CPI) rather flatters Britain’s inflation
performance. “Headline” retail price inflation was 3.9%, down from 4.1%.
RPIX, the retail prices index excluding mortgage interest payments, put
inflation at 2.8%.
This is still, however, very low in the context of an oil price of $90 a
barrel. Last year, after a summer spike that saw the price touch $80 during
the conflict between Israel and Lebanon, prices dropped sharply over the
winter, falling to $50 by January.
Some see this happening again this winter, from a higher starting point.
Supporting the price, however, is the strength of the global economy – this
is a demand-driven price shock rather than one created by limited supply –
and a considerable weight of speculative money.
The oil price and I go back a long way. Two years ago, as readers like to
remind me, I wrote we were in a “spike”, and the sustainable price – based
on real prices over 140 years – was $40 a barrel, not $80. In June I
conceded this was a longer spike, perhaps similar to that between the late
1970s and mid1980s.
I reckon about a third of the current price is due to geopolitical tension,
the flow of speculative funds into oil and other commodities, coupled with
the decision by Opec (the Organisation of Petroleum Exporting Countries) to
limit output. Another chunk, perhaps $10 to $20 a barrel, is due to the
extraordinary strength of the global economy. This is the fourth successive
year of 5% world growth. The International Monetary Fund (IMF) expects a
fifth, merely shading its forecast down to 4.8% for next year, continuing
the strongest run in living memory.
How long will these forces last? Hard to say. Alan Greenspan, in his book The
Age of Turbulence, reminds us that forecasts of dramatic oil-price rises
made at times of strain often come unstuck. In 1979, after the Iranian
revolution, the US Department of Energy predicted a rise in the oil price to
the current equivalent of $150 a barrel by 1995.
Greenspan has a word for those who believe global oil production is at its
peak, saying: “There is certainly enough oil in the ground to meet a rise in
world oil demand from 84m barrels a day in 2005 to 116m in 2030.” Whether
supply will be forthcoming is, he says, a political, not a geological,
question.
So far, the latest rise in oil prices has not had much impact, the recent
petrol-price rises being as much due to the chancellor raising excise duty
as the market. While oil is at a record in dollar terms, it is only
revisiting previous highs when measured in sterling.
Current high prices, if maintained, will have an effect. Most of the rise in
inflation we saw until earlier this year was directly and indirectly related
to oil and other energy. The Bank could face a similar problem again, though
this is where it gets interesting.
Retail sales rose last month by a strong 0.6%, suggesting consumers are not
dead yet. But this was achieved by a fall in prices. Despite dearer food,
average prices for retail goods fell 1.5% in the 12 months to September.
Inflation could stay low even as a fresh oil effect comes through.
That is not the only conundrum for the Bank. Last week’s MPC minutes were
interesting. They are signed off by the committee a couple of days before
publication, and my sense is that members wanted to get a message across.
A speech by King a week earlier was widely interpreted as hawkish, but that
may not have been the intention. Most of his talk was on Northern Rock; his
comments on monetary policy were intended to be neutral, and the minutes
were aimed at reinforcing that neutrality.
So the MPC has not made up its mind on whether to cut Bank rate. But it is
alive to the possibility that it may have to act if its own analysis
suggests the credit crisis will slow the economy too much.
The evidence is mixed. The latest Ernst & Young Item Club forecast is
headed “Credit Crunch – What Credit Crunch?”, suggesting the economy will
slow to 2.1% next year but that the effects will be contained. Gross
domestic product rose by a strong 0.8% in the third quarter. A survey of UK
chief financial officers by Deloitte shows the vast majority see little or
no impact on their business. The question for the MPC is whether it will
have enough information by next month to reach a decision.
There is another consideration for the MPC. I could have devoted a column to
the IMF warning of a UK house-price crash. Instead I wallowed in a little
nostalgia. This was almost the fifth anniversary of the first such warning
from the IMF, in December 2002 (when house prices were below their long-term
trend) and the crash or “correction” warnings have come thick and fast every
four to six months since. The Washington body has discovered the elixir of
generating headlines in Britain.
It could be that this is a “stopped-clock” forecast, which has to be right one
day. This is, as I have written, a testing time for the market. I prefer to
focus on the IMF’s caveats – it does not have a detailed analysis of the
British housing market, and local factors such as immigration and
housing-supply constraints will tend to support prices. But we’ll see.
PS: Will Alistair Darling bend on capital-gains tax (CGT), persuaded by
John Hutton, business secretary? Some loftily say the CBI, Chambers of
Commerce, Institute of Directors and Federation of Small Businesses are
wrong and should accept this tax-raising “simplification”. No.
Darling’s CGT shake-up – which increased the rate for small firms from 10% to
18% and abolished indexation relief for pre1998 inflationary gains – was a
significant error by the Treasury. Nobody outside its glass palace
overlooking St James’s Park was consulted, as officials admitted.
It was a gift for the opposition. The Tories lost business votes in the
recession of the early 1990s. Now they sense an opportunity. A report the
party commissioned from the European School of Management attacked the CGT
change and Gordon Brown’s earlier decision to raise the small firms’
corporation-tax rate from 19% to 22%. The tax system was becoming
“significantly less competitive”.
Labour has spent 10 years trying to establish itself as the enterprise party.
I had assumed Brown, in No 10, would go out of his way to show he was a
friend of business.
Is there a way out? Darling could abolish taper relief and indexation but
have two different tax rates, lower for business assets than second homes
and other nonbusiness assets. But there would be an outcry from the new
losers. John Whiting of Price Waterhouse Coopers suggests the Treasury could
reinstate the retirement relief that was part of the original post1965 CGT
system, shielding business owners who sell up to retire. Something has to
give.
david.smith@sunday-times.co.uk
