Telegraph: Pressure On Rates Boosts Sterling.

[munimula]

Producers being forced to pass on their cost increases which until now they have just absorbed.

This is the kind of point I'm trying to get from Karhu but his he isn't very forthcoming with any answers.

Look at the graph attached;

It shows massive input price inflation and yet CPI remains constantly low.

However this input inflation has been absorbed for so long why should it be passed on now?

[ca-uk]

maybe business decided to absorb costs as they thought the high input prices may be a blip or temporary - input prices go up as well as down and rather than upset the consumer they may have decided to take a temporary hit.

however, the high input prices seem not to be a short term blip..

this is a big *maybe* and just based on me having a quick ponder without any economic or other foundation..

[karhu]

This is the kind of point I'm trying to get from Karhu but his he isn't very forthcoming with any answers.

Look at the graph attached;

It shows massive input price inflation and yet CPI remains constantly low.

However this input inflation has been absorbed for so long why should it be passed on now?

All I'm willing to say is that you should be more preoccupied with rates and volumes than with the current figures. The current figures will tell you about yesterday and today. Rates (even second derivatives) and volumes will tell you about tomorrow.

The absolute mechanism of filtering through of inflation, money supply and CPI is extremely complicated and can only be attempted in a big computer simulation. However, basic empirical rules govern here. Basically, what I'm trying to say is that technical analysis is your friend now and fundamental analysis will get you frustrated and drive you nuts.

I don't mean to be arrogant M, but sometimes your Devil's advocate statements could be taken the wrong way

K.

[munimula]

Inflation is traditionally measured as the increase in money supply. We've discussed that ad nausium on here. You'll eventually see it in CPI it's inevitable. Just wait and see. It's like pumping gas into a metal container and expecting it not to explode even though you don't see it expanding.

That's rubbish. Inflation is the increase in cost of goods and services.

Increased money supply should mean that there is more money so that companies can increase prices because people can pay more but when the increase in money supply is largely to create debt then people actually have less money to spend so companies can't pass on prices. As we know now, retailers have been struggling because people are so indebted they have less disposable income so in fact retailers have to keep discounting, the opposite of increasing prices so inflation remains subdued

Also we have the china affect - continuously reducing prices of import goods keeping inflation down.

My point is simply that it is not a case of black and white. Service inflation is huge, goods inflation, largely due to china affect is low so overall inflation is low.

The only thing that will reverse this is an increase in goods inflation.

Why do you see that happening?

Edited May 5, 2006 by munimula

[karhu]

That's rubbish. Inflation is the increase in cost of goods and services.

The amount of currency in an economy (the Money supply) is stated as M0, M1, M2, M3 and M4 each more broad than the previous. As the amount of currency in circulation increases (inflation), its value decreases. This is the most direct way of measuring inflation as the amount of currency in bank accounts, bond, coins and paper notes, etc. is generally known to the government of each country. Observations of the money supply gives a much clearer picture of inflation because it responds quickly (as fast as banks report) and accounts for all inflation including that which occurs in finacial markets as rising stock prices.

http://en.wikipedia.org/wiki/Inflation#Money_supply

[munimula]

http://en.wikipedia.org/wiki/Inflation#Money_supply

But inflation (CPI) is measured by looking at the cost increases of a basket of services and goods. It is not measured by how much money is in circulation. The increase in the money in circulation SHOULD lead to higher inflation as companies can increase prices but in the current economic climate they can't so inflation is low and not increasing.

Also, you talk about large increase in money supply but is there necessarily a large increase in money 'in circulation'. As far as I'm aware the increase in money supply has been to provide debt which it would seem is not classed as 'money in circulation' therefore how does this increase in money supply that you talk of feed into pushing up inflation?

And again, an increase in debt would actually mean that there is less money in circulation as debt servicing sucks up money so the pressure on inflation is downwards.

Edited May 5, 2006 by munimula

[karhu]

You really should stop stating stuff like you have the last word.

Do you know what projections the BoE are making for inflation 2 years out? Probably not.

Actually, I do. Anyone on here could do it it's easy.

The last report we got from the Bank of England was for the projection to stay close to 2% throughout their 2 year window, but as Merv said there's little chance of that - in fact no chance!

Now consider their input parameters into the model. Recent data from the economy has become more bullish for growth and oil prices are staying high and US and Japan are raising their ineterest rates more aggressively, i.e., the BoE were too conservative in their modelling. Therefore, you'll see in the next few sets of minutes that the upside risk will now develop. The problem with inflation is that it tends to be one of those things that engages in positive feedback. You need it, but too much and it can spiral off into oblivion. Hence, the bank need to act quickly and decisively if they think that inflation is about to take off, which it is! No one knows how high interest rates will go, but believe me they'll do everything in their power to contain it, including going to 10% interest rates.

I'm not ruling out the possibility of a long term recession, but at the current time we're in a tightening cycle. We've been on the edge of that for a while now. Sorry for not giving you the exact date.

But inflation (CPI) is measured by looking at the cost increases of a basket of services and goods. It is not measured by how much money is in circulation. The increase in the money in circulation SHOULD lead to higher inflation as companies can increase prices but in the current economic climate they can't so inflation is low and not increasing.

Also, you talk about large increase in money supply but is there necessarily a large increase in money 'in circulation'. As far as I'm aware the increase in money supply has been to provide debt which it would seem is not classed as 'money in circulation' therefore how does this increase in money supply that you talk of feed into pushing up inflation?

And again, an increase in debt would actually mean that there is less money in circulation as debt servicing sucks up money so the pressure on inflation is downwards.

You're mixing inflation with price inflation. Price inflation could include house prices, for example, which has been increasing at 20% p.a. When equity prices stop rising, where's all that extra money going to go?

Edited May 5, 2006 by karhu

[munimula]

You're mixing inflation with price inflation.

But as you are banging on about interest rate rises and these are determined by inflation (CPI) then how is price inflation relevant?

[karhu]

But as you are banging on about interest rate rises and these are determined by inflation (CPI) then how is price inflation relevant?

CPI is price inflation. M3/M4 tells you about monetary inflation. The latter tells the BoE where CPI is heading. By the time you see it in CPI it's already too late!

[munimula]

Now consider their input parameters into the model. Recent data from the economy has become more bullish for growth and oil prices are staying high and US and Japan are raising their ineterest rates more aggressively, i.e., the BoE were too conservative in their modelling. Therefore, you'll see in the next few sets of minutes that the upside risk will now develop.

Agree, we should see this. Previous forecasts were made on a view of a deteriorating economy. However the pick up is very recent and based on what? A small increase in manufacturing and increasing house prices. I don't believe that either of these is now in a new upward trend, quite the opposite. I believe that consumption (2/3rds of GDP) is still on a downward trend and that actually current GDP forecasts are over optimistic.

I'm not ruling out the possibility of a long term recession, but at the current time we're in a tightening cycle. We've been on the edge of that for a while now. Sorry for not giving you the exact date.

Perhaps there will be a small tightening cycle, that does seem to be where we are but IMO it won't be long lived. House prices in the US coming off the boil, reducing US consumption and the collapse of the UK housing market will take us into recession. Perhaps this is 2-3 years away now though.

[MarkG]

However this input inflation has been absorbed for so long why should it be passed on now?

Because companies can't keep making losses forever? Maybe they'd even like to make a profit one day? Most of the cost-cutting they can do is already done, so the only future solution is price rises.

The scary thing is, once the costs start being passed on, interest rates will do very little to stop it, because the inflationary pressure has been building up for years. The BoE would have to cause a major recession to stabilise prices.

[munimula]

CPI is price inflation. M3/M4 tells you about monetary inflation. The latter tells the BoE where CPI is heading. By the time you see it in CPI it's already too late!

You are being confusing.

You previoulsy told me when I was talking about CPI that that was inflation and 'not price inflation'. You can't have it both ways, there are flaws showing in your knowledge of all this.

If price inflation has been increasing dramatically over the last 10 years then why didn't this tell the BoE that inflation was going to go higher then?

Your arguments don't stack up very well. I think I'll stick to my view.

Because companies can't keep making losses forever? Maybe they'd even like to make a profit one day? Most of the cost-cutting they can do is already done, so the only future solution is price rises.

The scary thing is, once the costs start being passed on, interest rates will do very little to stop it, because the inflationary pressure has been building up for years. The BoE would have to cause a major recession to stabilise prices.

Agree, inflationary pressures have been building for years. They might not be passed on though.

Companies could choose to reduce workforce before increasing prices and cheaper imported goods can maintain profitability.

[karhu]

Because companies can't keep making losses forever? Maybe they'd even like to make a profit one day? Most of the cost-cutting they can do is already done, so the only future solution is price rises.

The scary thing is, once the costs start being passed on, interest rates will do very little to stop it, because the inflationary pressure has been building up for years. The BoE would have to cause a major recession to stabilise prices.

MarkG, yes. The positive feedback nature of price inflation (or vicious cycle, if you like) means that you need to have the guts to put interest rates up well before the populous expects it. People on here think G. Brown has a hand in keeping IRs low, but if they were to do that it would lead to major instabilities later on that would be a magnitude worse than we're experiencing now.

Thing are not too bad. House prices are a little bit high and interest rates are on the way up. That will all be forgotten in 2 years time, except by those who bought into the low inflation/soft landing hypothesis.

[MarkG]

Companies could choose to reduce workforce before increasing prices and cheaper imported goods can maintain profitability.

What do you think they've been doing for the last decade? Why do you think they've outsourced so many jobs and replaced so many more with cheap immigrants?

How many more people do you think they can sack before there's no-one left to do the work?

[karhu]

You are being confusing.

You previoulsy told me when I was talking about CPI that that was inflation and 'not price inflation'. You can't have it both ways, there are flaws showing in your knowledge of all this.

If price inflation has been increasing dramatically over the last 10 years then why didn't this tell the BoE that inflation was going to go higher then?

Your arguments don't stack up very well. I think I'll stick to my view.

Agree, inflationary pressures have been building for years. They might not be passed on though.

Companies could choose to reduce workforce before increasing prices and cheaper imported goods can maintain profitability.

CPI is price inflation. The clue is in the name "consumer price inflation". It is causally related to monetary inflation (increase in money supply). The latter is the original definition of inflation, but our economies have become so complicated that the moneterist view has become less relevant. Greater stability may be achieved by using an empirical measure, such as CPI, or maybe not....

[munimula]

What do you think they've been doing for the last decade? Why do you think they've outsourced so many jobs and replaced so many more with cheap immigrants?

How many more people do you think they can sack before there's no-one left to do the work?

A lot. Unemployment is still relatively low.

Unemployment has been historically low so not sure where your view of massive workforce cuts comes from? Yes there have been big workforce cuts but those losing their jobs have obviously found jobs elsewhere.

CPI is price inflation. The clue is in the name "consumer price inflation". It is causally related to monetary inflation (increase in money supply). The latter is the original definition of inflation, but our economies have become so complicated that the moneterist view has become less relevant. Greater stability may be achieved by using an empirical measure, such as CPI, or maybe not....

OK then can you tell me why you expect inflation to increase?

You initially said that it will because of the increase in money supply but this doesn't add up as inflation is low and money supply has been increasing for years.

[MarkG]

Yes there have been big workforce cuts but those losing their jobs have obviously found jobs elsewhere.

Or been given early retirement or found that they magically had a medical problem which left them on incapacity benefit for the rest of their lives, or been hired into worthless government jobs. Unemployment is only low if you believe the government's unemployment figures, which are fiddled at least as much as the inflation figures.

In any case, it's largely irrelevant, because so few people work in jobs that actually make things these days. We know that inflation is high in commodities whose price can't be fudged, and service jobs which can't easily be exported, it's the cost of manufactured goods that makes inflation look low.

[munimula]

Or been given early retirement or found that they magically had a medical problem which left them on incapacity benefit for the rest of their lives, or been hired into worthless government jobs. Unemployment is only low if you believe the government's unemployment figures, which are fiddled at least as much as the inflation figures.

In any case, it's largely irrelevant, because so few people work in jobs that actually make things these days. We know that inflation is high in commodities whose price can't be fudged, and service jobs which can't easily be exported, it's the cost of manufactured goods that makes inflation look low.

I agree with what you are saying but I think there is a massive scope for job losses.

The two growth areas in jobs as manufacturing has declined and in particular since Labour came to power, have been public sector ans services, mainly retail.

As consumption makes up 2/3rds of GDP and as spending goes down then retailers will shed jobs and lots of services jobs, advertising, marketing etc will be lost too.

Public sector is maxed out after job hiring binge. As we have seen with the recent NHS cuts, the government can't really afford all the jobs it created.

Therefore, IMO public sector won't help support further increases in unemployment and IMO there are a lot of service sector jobs that could go if the HPC-Recession scenario plays out which I think it will.

In every downturn in housing a recession has followed. I expect this to be no different, it is just being dragged out longer than necessary by the BoE not facing upto it's responsibilities and the fudging of inflation figures.