James Klempster, head of portfolio management at Momentum, explains why Unilever and Tesco’s pricing disagreement may be a sign of trickier times ahead for inflation in the UK.
Consumer goods producer Unilever and retailer Tesco had a very public spat last week over the suggestion that the former’s prices needed to go up to reflect the impact of a weakened sterling on input costs. Since the surprise Brexit vote sterling has fallen 16% on a trade weighted basis implying that the UK’s imports have become more expensive. This, coupled with an increase in dollar terms of 35% in oil year to date (which translates to over 60% in sterling terms), suggests that the UK should expect to see growing inflationary pressures such as these in coming months.
Should inflation pick up it allows the Monetary Policy Committee of the Bank of England (BoE) far less wiggle room than it has become used to in recent years: the BoE has been able to keep its foot hard on the accelerator with ever looser monetary policy because inflationary fears have been modest of late. Were inflation to pick up it would put the committee in something of a quandary, especially if economic growth remains relatively meagre and fragile as strictly speaking the BoE should start to raise rates to stop the inflation rate exceeding the 2% target.
Over the recovery period post financial crisis central banks globally have been relatively relaxed with respect to inflation overshoots because growth has been poor and inflationary pressures have been transitory in nature. The BoE Governor, Mark Carney, suggested last week that he would remain sanguine for now, noting the committee would ‘tolerate a bit of overshoot in inflation over the course of the next few years’ in order to cushion the blow of an anticipated increase in unemployment.
The UK’s inflationary impulses, founded as they are on increased import prices and increasing energy costs, may also be transient because once the ‘base effect’ comes out in the wash then the force from price moves may dissipate. The risk in the UK, however, is that employment is reasonably solid and the squeezed consumer, who has had to put up with small (if any) real wage rises over the past few years, may simply demand greater wage increases which employers will struggle to push back on. In this case the inflationary forces become entrenched and self-fulfilling as inflationary expectations become embedded in wage inflation which again pushes up prices and so on.
More worrying for the UK is the spectre of stagflation, an environment where the economy stagnates but there is reasonable inflation. This is a painful period for consumers and while it does not have the ultimate consumption killer of deflation which encourages consumers to defer purchases which can be made at a lower nominal amount in the future, it will still be a knock to consumer confidence and squeeze either companies or consumers depending on which part of the consumption chain is forced to absorb any price increases.
We are also starting to see asset prices adjust to a higher inflation environment in the UK. Government interest rates are starting to drift up, causing falls in capital values of fixed income securities. Also other assets that have been used as an ‘income play’ as gilts were bid up are also starting to come under pressure as yields rise. Furthermore, the break-even inflation levels, a gauge of inflation expectations, have reached their highest levels since 2014 this month and it is this combination of rising yields, falling sterling and rising inflation expectations that will likely cause the BoE to tread carefully when considering their next move.
If the BoE’s Forbes is correct in his statement that we should expect inflation to overshoot its target ‘sharply’ over the next couple of years and that the days of ‘inflation bouncing around zero are gone’, this poses a significant risk for savers because even modest levels of inflation can significantly impact the real value of savings over the long term if nothing is done to protect against the ravages of inflation.