Is it time to worry about inflation?

UK retail price inflation doubled to 1.5 per cent in April, according to the headline CPI index, and goods inflation surged to 1.5 per cent from zero in March. Manufacturing output prices increased to almost 4 per cent and cost prices for manufacturers increased by almost 10 per cent.

So, is it time to worry about inflation?

Cost pressures are growing in an economy recovering from the loss of output during the pandemic. According to the latest PMI* data, businesses are experiencing the fastest increase in costs since August 2008. Manufacturers are facing price pressures due to shortages of raw materials and high shipping costs.

Strong demand for manufacturing supplies, higher transport bills and a spike in commodity prices, have resulted in the fastest increase in overall purchasing costs since the index began in January 1992. Service sector providers have reported increased staff salaries and difficulties in recruitment.

But strong customer demand helped to confer a “greater degree of pricing power” to businesses. Pass through rates are increasing and the data also reported the strongest rate of output price inflation since the index began.

Commodity prices have also surged. Brent Crude oil prices tested the $70 level in May, and it was trading at just $18 dollars in April last year. Copper prices tested the $10,000 level, doubling on the $5,000 dollar level from April 2020, and Iron ore prices traded at $220 dollars in May, compared to just $84 dollars last year.

Wild swings in commodity prices have been reported, from farm products to industry metals. Prices for corn, wheat and soybeans are surging and more volatility is expected as the US enters the heart of the growing season.

US lumber prices topped $1,700 in March, compared to just over $250 in the same period last year. Building material costs are increasing in the US and the UK.

Second-hand car prices are also featuring in the US CPI index and they have been soaring. The average value of used cars traded reached an all-time high in March. They averaged $17,000 for the month, up nearly 21 per cent from the same period a year earlier.

The global semiconductor chip shortage is a primary catalyst for this.

The demand for “chips with everything” has restricted the auto industry’s ability to manufacture new vehicles. Lower availability of new cars is prompting more people to shop for used vehicles. An increase in car rental demand is also forcing up prices as operators purchase used cars to augment their depleted fleets.

What will happen next?

The best cure for rising prices is rising prices. Shortages will resolve as output comes back on stream, but the rapid recovery in demand is catching suppliers out of step.

In the UK at the end of March, 4.2 million people remained on furlough. Over 500,000 were in manufacturing and construction, which is over 10 per cent of the total sector workforce. We expect a rapid bounce back in employment and productive capacity as the recovery gathers pace.

Shipping costs should also ease and the inflationary cost spike should prove temporary. World trade increased by almost 10 per cent in the first quarter of 2021. Transport fleets had been drifting in the wrong locations and the recovery in trade will soon normalise distribution and shipping costs.

‘Basing effects’ have compounded the rate of change of prices. US oil, on a WTI basis, traded at $16.55 dollars in April last year as demand collapsed and the oil rigs kept pumping. During one week in the month, traders were paid $35 dollars just to roll a barrel away. As low prices for all commodities drop out of the comparison data, the rate of increase will subside, and swiftly.

Underlying demand pressures on commodities have not changed too much. Growth of 8 per cent in China is expected this year, but the growth rate will slow to 6 per cent in 2022. The fundamentals of demand for commodities, including copper, are unchanged in what will soon become the largest economy in the world.

But evidence of stock building, hoarding and speculation is evident. Double ordering, and more, has happened as manufacturers are confronted with supply shortages. China has warned of “excessive speculation”, and prices have moved off their highs as a result.

The answer to the inflation question

This will be no return to double-digit inflation of the 1970s, when the collapse of the Peruvian anchovy crop, led to fears of hyperinflation spreading around the world.

But we expect prices, on a CPI basis, to rise to over 3 per cent in the next few months. The Bank of England expects prices to ease to 2.5 per cent by the end of the year, which is a fair bet.

Should we worry about retail price inflation? Probably not. It is, in central banker speak, a “transitory” phenomenon. Asset price inflation on the other hand is a different matter: house prices increased by 10 per cent in March.

*IHS Markit / CIPS Flash UK Composite PMI®

Disclaimer: The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The presentation should not be construed as the giving of investment or general consultancy advice.