The case in favour of rapidly falling inflation in the UK hinged on the idea that energy prices would, at some point, collapse. You’d have thought therefore that headline inflation would already be down quite some way.
The annual rate of transportation inflation — heavily influenced by changes in motor fuel prices — peaked at 15.2 per cent in June last year. Since, the rate has tumbled. The latest figures, for March, show an annual rate of a mere 1.0 per cent, the lowest since November 2020, long before Vladimir Putin’s invasion of Ukraine. Motor fuel prices themselves are now in decline, down 5.9 per cent over the last 12 months. Yet, in March, overall consumer price inflation was above 10 per cent for the seventh month in a row.
To be fair, other energy prices are still rising rapidly, and everyone knows they won’t be for much longer. Reversals in the coming months should be enough to drag so-called headline inflation lower. Nevertheless, the transportation story provides a warning for all those — including the Bank of England — convinced that falling energy prices represent a path back towards price stability. Yes, some prices are now tumbling. Others, however, are surging. Even if energy prices are “normalising”, there is nothing normal about our overall inflation experience.
Food price inflation is now running at 19.2 per cent, the highest rate since August 1977, the month in which Elvis Presley died and I was still doing a paper round. Back then, olive oil was used in the UK primarily to facilitate the removal of wax from one’s ears: a big olive oil “price shock” would only have led to temporary deafness. Today, olive oil is a major food staple, yet it has risen in price by almost 50 per cent over the last 12 months. Dairy and sugar prices have also surged: not good news for those of us with a sweet tooth.
Some will be tempted to say this all stems from Brexit, but gains in the UK are near-enough identical to those occurring in the EU.
So what explains this incredible surge? Obvious candidates include the lagged effects of earlier increases in energy prices and assorted bad harvests. Those who mistrust capitalism in all its perfidious forms will add that powerful companies are profiteering.
If, however, companies were really so powerful, why weren’t they raising prices earlier? Waiting for costs to rise before pushing prices higher doesn’t make a lot of sense if a combination of profit maximisation and pricing power really was the strategy all along.
In truth, inflation has always created both winners and losers. Those with pricing power — oligopolistic companies, powerful unionised labour — may “gain” during a period of inflation. Those who are price takers, unable to pass on cost increases, may “lose”. Those with large debts may see those debts “written off” in real terms — assuming their incomes rise relative to what they earlier borrowed — even as those with cash savings lose out.
Inflation is thus a profoundly unfair and undemocratic process, one that undermines public trust and slowly destroys social confidence.
In these circumstances, the losers naturally blame the winners. During the American Civil War, prices in the Confederacy rose twice as fast as wages, leading to accusations of price gouging. Price ceilings were imposed in a bid to stop such greedy behaviour yet inflation accelerated further. The same was true of the Nixon administration in the early Seventies. A Prices Commission was established to prevent companies raising prices yet inflation was held at bay only on temporary basis.
The lesson from the Seventies is that, if rising costs and prices are not met with tighter macroeconomic policies — chiefly in the form of higher interest rates — the chances are that price increases in one area will be followed by price or cost increases elsewhere. Setting the monetary “rules of the game” is incredibly important.
As Paul Volcker, head of the US Federal Reserve in the late Seventies and early Eighties, later observed, “the best results will be achieved if the inflationary threat is dealt with at an early stage, when the public is not yet fully alarmed, and that procrastination only invites greater difficulty”. Even though interest rates have now risen a lot, it’s not obvious that today’s crop of central bankers have heeded Volcker’s message.
Stephen King (@kingeconomist) is HSBC’s Senior Economic Adviser and author of We Need to Talk About Inflation, now available from Yale
