By Simon Rubinsohn, chief economist at Gerrard The jump in the closely-watched RPIX measure of i...
By Simon Rubinsohn, chief economist at Gerrard
The jump in the closely-watched RPIX measure of inflation in January from 1.9%-2.6% has raised a question mark over whether authorities are being complacent in their assessment of future prospects.
In the latest Inflation Report produced by the Bank of England, the base case profile for this key measure of inflation is shown to be below the 2.5% target until towards the end of the two-year forecast horizon.
This analysis was admittedly completed before the January figure was known but, in the press conference accompanying its publication, Mervyn King was quick to point out that short-term fluctuations in the RPI are normal and that there may be further erratic moves over the next few months.
If this unexpected number was, however, to signal the re-emergence of some degree of pricing power in the economy, the significance is twofold. On the one hand, it could force the authorities to begin the process of reversing the easing policy that took place over the course of 2001 before too much longer.
More positively, it could pave the way for a sharper recovery in corporate profitability that would be a particularly welcome development for the somewhat beleaguered equity market.
Yet, while inflation hawks have been springing out of the woodwork over the past few weeks, it is hard to find too much evidence in the January figure of a real change in the underlying inflation environment.
Much of the recent acceleration in inflation can be blamed on unhelpful base effects. More than a third of the overall increase is explained by the fact that, unlike in January 2001 when petrol prices fell sharply, this year they were unchanged during the month.
A sharp jump in seasonal food prices and smaller discounts on clothing in the January sales also contributed to the rise in inflation. This may appear to smack of seeking out excuses to justify a view, yet outside some parts of the service sector, we would contend that pricing power is still hard to find.
This does not necessarily mean that RPIX will spend most of this year below the official target level. A key factor determining this trend will be the actions of the Chancellor in the forthcoming budget.
While this may be pulling inflation in one direction, better news from the labour market will be pulling in the other. Stripping out the bonus element, private sector wage growth has now slipped to 4.3% compared with around 5% last summer. This, intriguingly, suggests that the key source of inflation pressure may actually be softening; if this is indeed the case, talk of a deterioration in the underlying trend is certainly premature.
Against this backdrop, the expectation built into money markets that interest rates will be pushed up to the 5% area by the year end appears aggressive to say the least. The fact that monetary policy may remain on hold for longer than anticipated is not all good news as far as the equity market is concerned.
If pricing power does prove more elusive than indicated by the latest inflation data, it could turn out to be rather harder to rebuild corporate profits, putting even more of the burden on further cost cutting.
Better news from the labour market.
Potential improvement in corporate profitability.
Re-emergence of pricing power.
Economic complacency may be creeping in.
Interest rates look likely to rise.
High levels of consumer debt.
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