The UK faces a serious inflation issue if oil pops!
Bond markets are pricing in rate hikes this year by the ECB and the BoE. Both are inflation targeters, so which one should react first to a possible spike in oil prices? What’s your answer?
(1) Neither. As FX appreciation and fiscal austerity pass through to domestic prices, the core will drag down the headline. If they hike, stagflation will result.
(2) The ECB, because it is the most hawkish of all central banks, in my view. The ECB mandates a rigid targeting scheme compared to that of the BoE. Since the January 2005, the BoE has successfully targeted inflation slightly under 2% just 27% of the time, while ECB has done so 61% of the time.
(3) The UK. The January 2011 UK inflation rate was 4% Y/Y (3.2% in November on a harmonized basis) and near-double that in the Eurozone, 2.4% according to the flash estimate.
Furthermore, the UK story is not one of just energy and food. The chart below illustrates the diffusion of price inflation across the components of the harmonized HICP (data at Eurostat), and the legend lists the period average for each economy. Diffusion levels above 50 indicate that a larger share of component prices are growing at an annual rate above 2% that below 2%. The diffusion a measure of the breadth of price pressures…
…and is UK inflation broad-based! In contrast, inflation in the Eurozone is focused in the commodity and energy space. Now, I’m not suggesting that the BoE hike – in fact I would recommend the opposite, or at least stay on hold – but I’m sure that the BoE has its vision acutely focused on developments in the Middle East.
If I had to choose an economy that would be derailed by the price spikes in the commodity space, it would be the UK. But I choose (1).
How much of inflation in the the UK has been due to the two boosts in the VAT? The VAT rate was raised from 15 to 17.5 in January 2010 and to 20 in January 2011. The great inflation in the UK is a total illusion. And the sad thing is it is reinforcing the inflation hawks.
Hi Rebecca – still a daily visitor to newsNeconomics for the daily links and your eventual return!
I tend to agrre with Mark. Also, doesn’t the UK still have meaningful (even if declining) oil and gas production? Wont the tax take on this help cushion some of the blow?
Hi Mark, I tend to agree, which is why I took option (1): they shouldn’t hike becuase the effects will prove to be temporary. If they hike, they may have a stagflation problem on their hands with surging energy prices (if they do in fact surge) and crimping demand (from the hike and fiscal austerity). Te UK’s already producing well below its capacity average.
You ask, “How much of inflation in the the UK has been due to the two boosts in the VAT?”
Eurostat produces a ‘constant tax’ measure of HICP. Essentially they assume that the VAT hikes were fully passed through to final goods prices and then extrapolate the underlying inflation rate. In the latest available month, November, it was 1.5% in the UK (on a harmonized basis, so the headline comparable is the Eurostat reported 3.2%). So roughly half.
The BoE can’t effectively hike – but it will. The ECB, too. Inflation-targeting is very likely a central bank policy that will loose its popularity in years to come. I agree with Kantoos (and Kantoos, from where you came 🙂 and David Beckworth, and Scott Sumner, that a nominal GDP target, while logistically difficult, is probably your best bet to get the real and nominal aspects of a central bank mandate. Good old regulation is also required (in the case of the US)!!!
Stevie, Please see my response to Mark (which was a response to you, too!).
I know, I miss News N Economics, too. For now, publishing once or twice a week at Angry Bear is great because I free up a bunch of time for work. It’s logisitically overwhelming to run a website, so I had to choose. Later this year (summer), it’s very likely that I will reopen News N Economics.
Thanks for your loyalty over the years! Keep coming here until I return to News N Economics. I was toying around with the idea of chanigng the name of the site….
Here’s one you won’t believe in. The USA will go first. ZIRP and QE in the US are contributing to the global inflation we are now seeing. The Fed will be forced to back off. It happens before June.
“Forced” by what? Will the Fed change gears, and ignore its legally established mandate, by taking conditions outside the US into account?
“Back off” of what? Truncate the asset purchase program or actually reduce accommodation by selling assets or hiking rates?
Bernanke’s argument, stated repeatedly, is that other central banks have the capacity to control inflation within their borders, and that in many cases currency flexibility would be a big contributor to the stability of their prices. Rigidities elsewhere contribute to inflation elsewhere, and that remains Bernanke’s argument against doing anything about inflation elsewhere.
The BoE will have to apologize to Parliament for missing its target – again – but Parliament should not be all that upset. Tax hikes are not all nominally inflationary, but VAT hikes are, and Parliament imposed the VAT hike. Tax hikes are also likely to contribute to slower growth, which the BoE can try to offset by maintaining easy money.
Policy coordination, when done well, can make for far better results than having fiscal policy drive where ever politics take it while locking monetary policy into rigid rules. Since Parliament is not designed to do much of the coordinating, then it’s up to the BoE.
Like this post a lot, by the way.
Forced by the inflation numbers that will be coming over the next few months. He is bound by his word. Inflation less than 2% is what he has pledged about 100 times in the last few months.
2% is a forgone conclusion.
I am going with (3). BOE.
I was not aware that Eurostat had a “Harmonized Index of Consumer Prices (HICP) at constant tax rates”. (I probably should have known this but the amount I don’t know constantly amazes me.)
Given that the HICP in the UK was up 3.2% yoy in November, that core HICP was up 2.5% yoy in November, and that the HICP at constant tax rates was up 1.5% yoy in November this suggests that if there was a “core HICP at constant tax rates”, (using simple subtraction) it would be up by 0.8% yoy in November. Which underscores the fact that the hysteria about inflation in the UK is a lot of nonsense.
Now I think price level targeting is superior to inflation targeting, and that NGDP level targeting is better still. But if you are going to target inflation rates then you should at least be targeting a measure of “inflation inertia”. The headline HICP in the UK is seriously skewed by the volatile energy and food component and the two VAT increases. Using the correct measure of inflation inertia, the real danger in the UK right now is deflation, not inflation.
Bernanke usually means core inflation when he talks about policy, and core inflation is not likely to come near 2% in the next few months.