The OECD is predicting a pretty dire growth rate for the UK next year, the worst in the G20 apart from Russia. And it is laying this at the door of our high inflation rate and high tax burden.
We won’t know what the latest inflation numbers are until 22 June but Huw Pill, chief economist at the Bank of England, is concerned about inflationary psychology taking hold – with high inflation becoming embedded in wage and price setting behaviour. We should all fear this. A colleague recounts how her local taxi firm quoted £300 for a round trip that previously cost at most £120. I don’t doubt that the hike reflects problems faced by the company regarding staffing, fuel, vehicle costs and so on. But if a taxi firm can charge what it likes, it suggests a momentum that will be difficult to harness and tame.
The Bank of England expects inflation in the UK to hit double figures by the end of this year before returning to its 2 per cent target by 2024. Is this wishful thinking? A suppression tactic? Is it likely to happen? Given how important the inflation question is to the decisions made by businesses, savers and investors (although there is evidence that inflation makes little difference to equities over the long term – see Bearbull), it’s worth exploring this further.
The mix of (constantly evolving) external factors behind this bout of inflation make it difficult to predict its course. But we know the chief culprits. The first is soaring energy prices, the result of rising global demand for oil and gas (less polluting than coal) clashing with supply issues. Supplies are down because production was cut as demand fell during the pandemic and as the great transition away from fossil fuels began in earnest. Wells have been closed and plans for new ones ripped up. On top of that there are war-related port blockades and boycotts, and competition is rising for limited supplies of the hugely popular LNG.
Easing tightness in energy markets is crucial. The Monetary Policy Committee’s forecast decline in inflation is largely based on energy prices falling. But to ease tightness, oil and gas supplies must increase. This might happen: Opec says it will increase output in July and August. Peace in the east would help, too. And producers are rethinking their future plans.
Second on the list is the rocketing price of other commodities such as fertiliser component ammonia (production of which requires heavy gas usage), the doubling of potash prices and runaway demand for key metals and minerals. Electric vehicle makers need copper and nickel and their prices have never been as high. Steel and lumber have suffered the same fate.
What will bring the prices of these important materials down? Mining companies are already working on increasing supplies to meet demand in the future. But opening new mines is fraught with difficulty and takes years. Redesigning cars and batteries, scrap and technology could help too, but few of these can deliver in the short term. An economic downturn in, and therefore demand from, China would also alleviate tension.
Next is the lingering supply chain disruption stemming from the pandemic (eg, factory closures and delivery disruption). Demand for goods and services has exploded but suppliers are ill-prepared. China’s continuing zero Covid policy hasn’t helped. But of all the pressures on prices, this one should be relatively easy to unknot.
Fourth on the list is the shortage of workers. The UK workforce has shrunk post Brexit while the pandemic has prompted many people to leave work for good. The unemployment rate now stands at 3.6 per cent.
However, unemployment should rise as rate hikes and high prices cause a slowdown or even recession.
There are other shortages, too, of wheat and oil (the non energy types) in particular. These have been exacerbated by the war in Ukraine, the retreat of globalisation and the growth of resource nationalism with countries banning exports of in-demand commodities. But bans on exports are likely to be short term. We shouldn’t exaggerate the deglobalisation threat, either. Businesses are likely to widen their range of suppliers and to focus on “friendly shores”, but they are not likely to bring all their requirements back home.
So some inflationary forces are transitory, some are sticky. In the meantime central banks are tipping on buckets of cold water to help do what they can to nudge the inflation rate down (they have also stopped pumping money into the markets). Whether or not they can help ‘fine tune’ economic and price developments is however something that not even Huw Pill is sure of.
