It’s that time of year again, when many companies set their budgets for the coming 12 months and beyond. The future is always uncertain, so most of these plans will quickly get blown off course. But at least we can be sure of one thing, right?
This is that as energy, shipping and goods prices subside, inflation will fall back sharply, taking the pressure off companies for wage and price increases. Quite how far it will fall is unfortunately a different matter.
If the current inflationary surge is largely down to external factors, there are worrying signs – particularly in service industry inflation – that domestic elements are taking over from international ones.
Will inflation, as forecast by the Bank of England in its latest Monetary Policy Committee Report, be back at 4pc by the end of this year, and then carry on down, perhaps even undershooting the official inflation target of 2pc soon after? Or will it get stuck in the 4-5pc range, which would require interest rates to remain higher for longer?
To pretend definitively to know the answer to this question would be silly, but the balance of risk is obvious for a country which is perhaps more culturally prone to inflation than peers – and where, whatever the Government says to the contrary, the dam on public sector pay is quite plainly about to burst.
One way or another, the current wave of strike action has to be brought to a negotiated settlement; inevitably that’s going to involve public sector wage inflation well above the 1pc rise the Government has pencilled in for total departmental resource spending next financial year.
By the way, the argument often used by unions, that public sector pay rises are not inflationary because public services are free to use and therefore don’t carry a price, is close to ridiculous.
Inflation in public sector pay both adds to aggregate demand, pushing up prices accordingly, and increases the competition for labour, raising wages in the round. Companies then pass on these costs by raising prices.
In any case, we know that inflation has peaked and that the pressures are easing; what we don’t know is quite how far down it’ll go. That debate is reflected in an increasingly sharp divide on the Bank’s monetary policy committee itself. Two members voted against the 0.5 percentage point rise in interest rates at last week’s meeting. For them, the inflationary story, and consequent monetary tightening, is already over.
But for Catherine Mann, it very definitely isn’t. In a speech on Monday she insisted that there was a real risk of inflation becoming embedded, which in turn justified continued tightening.
The costs of making a mistake if inflation proves more persistent than assumed are greater, she argued, than if inflation is less persistent, at which point the Bank could easily reverse ferret and ease off the monetary brakes. But to be forced into renewed tightening at a later stage having prematurely eased off would be much more damaging.
I obviously can’t claim to have an inside track on what corporate planning as an aggregated whole assumes for the year ahead, but anecdotally the evidence seems to point more to the Catherine Mann viewpoint than the Bank’s official prognosis. My sense is that there remains a strong presumption among bosses of continued pricing power, and upward pressure on wages to match.
Again, this cannot be taken as evidence of the wider picture, but the other day I received a renewal notice for my car insurance from Admiral Insurance detailing without explanation and after more than a year of no-claims a 50pc increase in the premium for the next 12 months.
This increase was “generously” cut by a half after I threatened to take my custom elsewhere, but this still left the policy with an overall inflation rate of 25pc.
Auto replacement costs had gone up dramatically, Admiral later insisted by way of justification, which may be true, but is just further evidence of quite how embedded the idea of rising prices has become in the corporate mindset.
Monetarists tend to argue that the inflationary shock is now substantially behind us; rather it is the threat of price disinflation and central bank overkill we need to worry about more.
The monetarists were much more on the money than central banks and most Keynesians about the dangers of inflation as economies emerged from the pandemic, so they cannot now be lightly dismissed.
Historically there has always been a strong correlation between monetary growth and consumer price inflation, if sometimes with a very long lag. As directional indicators, the monetary aggregates are more reliable than most.
Yet as Paul Dales, chief UK economist at Capital Economics, points out, good as they are, they cannot tell you exactly where inflation is going to settle.
Unfortunately, there are a number of reasons for believing it may prove somewhat stickier here in the UK than the US and the Eurozone.
One is reluctance to work, which since the pandemic has proved rather stronger here in the UK than most other developed economies; astonishingly, more than one in seven of working age, or 9m people in total, don’t work.
On top of that, we have a widening skills mismatch. For those who want them, the jobs are there but the required skills are not. The result is intense competition for labour, driving up wages.
The Government may be trying to hold the line on public sector wages, but it has “helpfully” decided to push up the minimum wage that applies to the economy as a whole by nearly 10pc.
If you want to know why Lithuania has an inflation rate of 20 percent, look no further than the minimum wage, which the Lithuanian government has raised by 50 percent in four years. Proportionately, far fewer workers here in Britain are on the minimum than Lithuania, but not surprisingly a higher floor tends to push up wages across the spectrum.
A second reason for believing in the stickiness of UK inflation is that culturally, we are very used to seeing our living standards protected, and therefore expect wage increases that at least match inflation. Companies too expect to at least maintain the real value of their profits. Still strangely immune to the cleansing influence of open competition in many sectors, they push up their prices accordingly.
There may now be a bit more resistance to price setting than there was last year, but as Admiral’s usurious premiums suggest, the instinct is as strong as ever. Among both employers and employees there is a marked reluctance to acknowledge that national income has inescapably been harmed by three years of economic shocks, from Brexit to Covid and war in Ukraine.
Resistance to this adjustment is what lies behind elevated inflation, and for now it shows stubbornly few signs of going away.
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