WHEN the oil price hit $100 a barrel at the start of this year, it was a
curiosity but not a cause for great alarm. The price had, after all, topped
$70 in the summer of 2005 when Hurricane Katrina struck, risen above $80 in
2006 and been hovering in the $90s for some time.
But last week’s climb to more than $135 a barrel was different. It meant that,
far from retreating from the giddy heights of $100, the price of crude had
risen 35% in five months, and doubled in a year. In two days last week oil
jumped by $7. This was not just commodity price inflation, it was something
more like crude-oil hyperinflation.
With it came almost daily rises in the forecourt price of petrol and diesel.
And with oil and other commodity price rises yet to feed through to the cost
of most products and services, a new and worrying consensus is emerging in
the financial markets and business.
The fear is that this is not a short-term inflation blip, as the Bank of
England and the Treasury want everybody to think, but a more permanent shift
into a more inflationary world.
Tim Bond at Barclays Capital put it bluntly. “We have no reason to expect that
the inflation outcome over the next few years will be much different to the
outcome in the 1970s.”
The 1970s was when the postwar golden age of the global economy came to an
abrupt end, ushering in the era of “stagflation” - economic stagnation and
recession alongside roaring price increases.
To some the parallels are disturbing. Then, as now, the world had been through
a period of strong growth; in the past four years the global economy has
expanded at the fastest rate since the early 1970s. Then, as now, the first
warning signs came from the rise in commodity prices. Then, as now, the
finger of blame was pointed at the Organisation of Petroleum Exporting
Countries (Opec).
In 1973-74, the oil producers’ cartel discovered how to use its power to
quadruple the price in a matter of months. If predictions of a $200-a-barrel
price this year prove correct, Opec will have achieved a similar result,
though from a much higher base.
In Britain inflation hit 27% in 1975 and most industrial countries experienced
double-digit price rises. Bond does not expect a repeat of that but he warns
that inflation will be significantly higher than in recent years and that in
emerging economies it is as bad as the 1970s.
“At the moment monetary policy on a global basis is very loose and central
banks don’t have the tools to deal with a big rise in international
inflation,” he said.
Andrew Milligan at Standard Life Investments said Britain was experiencing
“stagflation lite” but warned that investors had to be prepared for greater
inflation volatility. Any sign that the government was relaxing the Bank of
England’s inflation target would go down very badly, he added.
The Economist magazine predicts that, as a result of higher food and energy
prices, two-thirds of the world’s population will experience double-figure
price inflation this summer. In China, where inflation is 8.5%, higher
commodity prices and 18% wage inflation could be a harbinger of things to
come. A 60% average rise in food prices over the past year is devastating
for poor economies where food comprises a high proportion of spending.
Earlier this month John Lipsky, deputy managing director of the International
Monetary Fund, warned that the return of inflation threatened the stability
of the global economy.
“To put the issue starkly, inflation risks have reemerged as a global
challenge following a long absence,” Lipsky said.
He warned that some of the upward pressures on global inflation, from rising
food prices, were unlikely to abate soon. “Hopefully, the inflationary
impulse from higher food prices will wane, even if prices do not retreat
significantly. However, this also indicates that the humanitarian challenges
of higher food prices will not disappear any time soon,” he said.
In Britain, while inflation is a modest 3% on the consumer prices index and
4.2% according to the retail prices index, the pressures are also growing.
Official figures show that industry’s raw-material and fuel costs last month
were 23% up on a year earlier while output or “factory gate” prices were up
by 7.5%.
Both were the highest since the figures started to be compiled on the present
basis in 1986. Business is feeling the effects of high inflation as much as
consumers.
TANDEM TRANSPORT, a South Wales haulier, was planning to invest in four new
vehicles this year to add to its fleet of 25. Now, said managing director
Vincent Brickley, the company is having second thoughts.
The rapid rise in fuel prices over the past year has cut profit margins to the
bone, and Tandem, in common with smaller haulage companies all over Britain,
is struggling to pass on the price increases to customers.
“I was with a customer this morning who was not having any of it,” said
Brickley. “If we can’t pass on the increase, we will in some cases have to
walk away from the work. It’s not as if haulage has ever been a high-margin
business. Now it is painful. You would be better off leaving your money in
the bank.”
Tandem was paying 89.3p a litre for diesel a year ago (along with other
business purchasers, it pays an ex-Vat price). Now it is 107p. “I went off
for a holiday a little while ago and it was 99p a litre. When I came back it
was 106p,” said Brickley. Fuel now accounts for 40% of the company’s
operating cost, and its fuel bill is likely to hit £800,000 this year,
compared with £570,000 last.
Brickley said hauliers had suggested to politicians a targeted relief for the
industry by increasing the weighting of Vat in the government’s take from
the increased fuel price. “We are saying leave the price where it is, but
have less duty and more Vat, which we as haulage companies can claim back,”
he said.
Larger transport companies are better off, as most have contracts that protect
them from fuel-price rises. Andrew Tinkler, chief executive of Stobart
Group, said: “The impact of fuel-price movements on financial performance in
the last year has been negligible due to the use of fuel-price escalators
within all customer contracts. Ultimately, however, it will be consumers who
feel these increases most on their shopping bills, as retailers pass on the
costs.”
This is one of the big worries - that high prices will feed through to the
cost of other goods and eventually wages.
Ian McCafferty, chief economic adviser at the CBI, said costs and prices were
the hot issue among the employers’ organisation’s members, much more than
the impact of the credit crunch.
“Demand in most sectors is still holding up remarkably well and most
businesses can still get capital even if they have to go through a few more
hoops to do so,” he said. “The concern is about rising costs.
“For me the worrying thing is that, while the rise in energy and commodity
prices last autumn was being cushioned at the consumer level by companies
taking a hit on margins, firms are now saying they can’t do that any more
and have to pass it on.
“We’re still talking mainly about commodity and energy-intensive products, but
there is a change.
“The good news is that it does not appear to be affecting wages yet. People
tell me they are settling for no more than last year.”
In the 1970s, the direct impact of higher oil and commodity prices was
compounded by so-called second-round effects as wage negotiators sought and
received higher pay settlements in response. The wage-price spiral ensured
that the initial price shock was both magnified and long-lasting.
Even if that is not the case, some businesses have been left teetering on the
brink by the sharp rise in energy costs. The business models adopted by many
airlines and the era of cheap flights seem to be in jeopardy.
The high fuel price is expected to batter the airline industry, with smaller
and weaker airlines going to the wall if the oil price remains above $110 a
barrel. Jet fuel last week hovered at more than $1,300 a tonne, a record
price.
Silverjet, a luxury airline that flies from Luton to Dubai and New York,
suspended its shares on Friday after saying it had been unable to get funds
promised by a Middle Eastern investor. Two of its rivals in the all-business
sector, Maxjet and Eos, have already gone out of business after investors
failed to stump up the new funding they needed.
British Airways, which 10 days ago reported a record trading year, has warned
that it, too, will suffer. Finance director Keith Williams told analysts
that at oil prices greater than $120 a barrel, the company’s profit margin
shrinks to zero.
Sir Michael Bishop, chairman of BMI British Midland, last week warned of
“difficult trading conditions” and said there was little immediate prospect
of an upturn. IS there a way out? Not all commodities are rising. Many
industrial metals peaked some time ago and are well down, hit by the
slowdown in the global economy. Overall, the price of industrial metals is
down 7% on a year ago. Some, such as zinc and nickel, have fallen very
sharply.
While many analysts predict further big rises in the price of oil, saying that
$200 a barrel is possible this year, others, including Lehman Brothers,
think the price will snap back to a more realistic $80. Helping this process
along, say some, will be moves by governments in emerging economies to scrap
oil-price subsidies.
“The trend towards cutting fuel subsidies will increase the sensitivity of
demand to higher global oil prices and make it less likely that the recent
surge in the cost of crude oil will be sustained,” said Julian Jessop of the
consultancy Capital Economics.
“These changes will not transform the market overnight, but underline the
point that ever-accelerating demand for commodities from fast-growing
emerging economies cannot be taken for granted.”
David Blanchflower, the only member of the Bank of England’s monetary policy
committee to vote to cut interest rates this month, thinks worries over
inflation will be transitory. He suggested in a recent speech that inflation
could threaten to break below the lower point of the acceptable range, 1%,
before his term on the MPC expires next year.
Some economists agree the inflation scare has been overdone. David Owen of
Dresdner Kleinwort, in a note called Inflation or Deflation?, argued that
while worries about the return of inflation were likely to persist for the
next 12 months, the medium-term outlook was very different.
“Nobody is interested in this story at the moment,” he said. “But we believe
that unless you think core inflation is going to increase sharply it will be
very difficult to get high headline rates of inflation.
“Central banks and investors are fearful that inflation expectations will push
up core prices and entrench the inflation problem,” he said. “This is a
genuine fear, but our cyclical models of inflation suggest deflation
[falling prices] is a bigger risk on a three to five-year view than
seriously high inflation.”
Even if that is correct, however, getting to the medium term is going to be
tricky for the economy and challenging for business. It may not be a return
to the 1970s, but it is very different from the experience of recent years.
For many firms it will be too different for comfort.
