Growth in the UK for the final quarter of 2010 was originally at -0.5%. However, the latest data has revised that figure to -0.6% and not all of this was down to the snow. Analysts say that the snow effect is still believed to explain the 0.5% contraction, but the economy therefore declined by 0.1% because of other reasons and retailers have seen the effects. Primark has reported a ‘noticeable’ slowdown in demand since the beginning of 2011. With increasing VAT and rising cotton prices, clothing retailers are feeling the squeeze. The same is true of UK consumers. With an increase in VAT and high inflation, consumers’ purchasing power has simply fallen and so they are spending less. Despite this slowdown, Primark’s revenues are still significantly ahead of the same time last year.
The parent company, Associated British Foods (ABF) commented on the disappointing trading of 2011 so far, saying:
“Since the New Year, the performance in all our operations in Continental Europe has been very encouraging but there has been a noticeable slowing down of UK consumer demand.”
However, despite disappointing figures for Primark, UK retail sales did pick up in January, although analysts are warning against taking this information as a sign of recovery. As Hetal Mehta from Daiwa said:
“While we expected there to be some clawback from December’s dismal, snow-hit retail sales, today’s jump is a welcome surprise. But is still far too early to conclude that consumers are weathering the storm … and with the past week’s unemployment figures highlighting the fragility of the labour market, the housing market continuing to weaken and real earnings being hit hard by high inflation, it seems inconceivable that consumer spending will act as the driving force of the economy over the near term.”
There are many opinions about what to expect from the economy in 2011, but for any concrete information, we really have to wait for at least another month. Perhaps by Easter, we’ll have a better idea about the state of the UK. For now, there are a few articles considering the retail sector.
Primark owner warns of slowing sales in UK Guardian, Graeme Wearden (28/2/11)
Primark warns of ‘noticeable’ slowdown in UK demand BBC News (28/2/11)
Growth in UK retail sales slows sharply Wall Street Journal, Alex Brittain and Art Patnaude (24/2/11)
UK retail sales rebound: reaction Telegraph (28/2/11)
UK GDP figure revised down further BBC News (25/2/11)
Questions
- Why has higher VAT and cotton prices impacted retailers such as Primark?
- Why was Primark less affected by declining sales in the run up to Christmas?
- What do we mean by purchasing power?
- Why is it hard to draw any conclusions about the performance of the UK at the moment?
- What does a slowing down of retail sales mean for the UK’s recovery? Will it influence the Chancellor’s Budget?
Every quarter, the Bank of England publishes its Inflation Report. This analyses developments in the macroeconomy and gives forecasts for inflation and GDP growth over the following 12 quarters. It is on the forecast for inflation in 8 quarters’ time that the Bank of England’s Monetary Policy Committee primarily bases its interest rate decision.
According to the February 2011 Inflation Report forecast, CPI inflation is expected to be at or slightly below its 2% target in two year’s time, but there is considerable uncertainty about this, as shown in the fan diagram in Chart 3 of the Overview. What is more, inflation is likely to rise considerably before it falls back. As the Report states:
CPI inflation is likely to pick up to between 4% and 5% in the near term and to remain well above the 2% target over the next year or so, reflecting in part the recent increase in VAT. The near-term profile is markedly higher than in November, largely reflecting further rises in commodity and import prices since then. Further ahead, inflation is likely to fall back, as those effects diminish and downward pressure from spare capacity persists. But both the timing and extent of that decline in inflation are uncertain.
It is interesting to look back at the Inflation Reports of a year ago and two years ago to see what was being forecast then and to compare them with what has actually happened. It’s not too difficult to explain why the forecasts have turned out to be wrong. Hindsight is a wonderful thing. Unfortunately, foresight is less wonderful.
Articles
BoE forecasts pave way to rate rise, but King cautious Reuters, Matt Falloon and Fiona Shaikh (16/2/11)
Inflation report: what the economists say Guardian (16/2/11)
Inflation will rise sharply, says Mervyn King BBC News (16/2/11)
The unrepentant governor BBC News blogs: Stephanomics, Stephanie Flanders (16/2/11)
Inflation: Mervyn and me BBC News blogs: Idle Scrawl, Paul Mason (16/2/11)
What would Milton do? The Economist, Buttonwood (16/2/11)
Why inflation hawks are still grounded Fortune, Colin Barr (16/2/11)
Podcast and Webcast
Bank of England Press conference: Podcast (16/2/11)
Bank of England Press conference: Webcast (16/2/11)
Inflation Report
Inflation Report, portal page for latest report and sections, Bank of England
Inflation Report, February 2011: full report, Bank of England
Data
Forecasts for the UK economy: a comparison of independent forecasts, HM Treasury
Prospects for the UK economy, National Institute of Economic and Social Research press release (1/2/11)
Output, Prices and Jobs, The Economist (10/2/11)
Questions
- Examine the forecasts for UK inflation and GDP for 2010 made in the February 2009 and February 2010 Bank of England Inflation Reports. How accurate were they?
- Explain the difference between the forecasts and the outturn.
- Why is it particularly difficult to forecast inflation and GDP growth at the present time for two years hence?
- What are the advantages of the Bank of England using a forward-looking rule as opposed to basing interest rate decisions solely on current circumstances?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
- What do you understand by the term ‘core’ inflation? Is this the same thing as demand-pull inflation?
- How is the Bank of England’s policy on interest rates likely to affect expectations? What expectations are particularly important here?
- Explain whether or not it is desirable for interest rates to be adjusted in response to external shocks, such as commodity price increases?
In March 2009, the Bank of England’s base rate was slashed to 0.5% in a bid to boost aggregate demand and stimulate the UK economy. And there it has remained for almost 2 years and as yet, no change is in sight. In the February 2011 meeting of the Monetary Policy Committee (who are responsible for setting interest rates to keep inflation on target), the decision was to keep interest rates at 0.5% rather than raise them to tackle high and rising UK inflation. Those in favour of keeping interest rates at this record low argue that any increase could damage the UK’s ability to recover and may lead to the dreaded double-dip recession. This is of particular concern given the economy’s performance in the last quarter of 2010.
However, one group that will certainly not be happy is the savers. With instant-access savings accounts paying on average just 0.84% before tax and with inflation at 3.7%, savers aren’t just not gaining much interest, but are actually seeing the value of their money in real terms fall. Howard Archer of HIS Global Insight said:
“For now, we retain our view that the Bank of England will hold off from raising interest rates until the latter months of the year. Even if interest rates do rise in the near term, the likelihood is still that they will rise only gradually and remain very low compared to past norms.
Monetary policy will need to stay loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Consequently, we retain the view that interest rates will only rise to 2pc by the end of 2012.”
Following some speculation that the Bank of England may succumb to the pressure of inflation and hike up interest rates (markets had priced in a 20% chance of a rate rise), sterling did take a hit, but after the decision to keep rates at 0.5%, sterling recovered against the dollar. There is a belief amongst some traders that rates will rise in May, but others believe rates may remain at 0.5% until much later in 2011, as the country aims to avoid plunging back into recession. Of 49 economists that responsed to a poll by Reuters, three quarters of them said that rates would rise by the end of 2011, with median forecasts predicting a rise around November. This is certainly a space to watch, as it has implications for everyone in the UK and for many in countries around the world.
BOE leaves bank rate unchanged at 0.5% at Feb meeting Automated Trader (10/2/11)
Economists predict interest rates will rise in November Telegraph, Szu Ping Chan (11/2/11)
UK May rate hike view holds firm after BOE Reuters, Kirsten Donovan (10/2/11)
Interest rates: What the economists say Guardian (10/2/11)
Fixed rate mortgages becoming more expensive BBC News (10/2/11)
Bank rate: savers’ celebrations on hold Telegraph, Richard Evans (10/2/11)
Inflation fears turn up heat ahead of bank rate decision City AM, Julian Harris (10/2/11)
Sterling takes BOE in its stride, higher rate talk aids Reuters, Anirban Nag (10/2/11)
Bank of England holds interest rates of 0.5% Telegraph, Emma Rowley (10/2/11)
Questions
- Why are interest rates such an important tool of monetary policy? Think about which variables of aggregate demand will be affected by the Bank of England’s decision.
- What is the relationship between interest rates and inflation?
- What explanation is there for the fall in the value of sterling following speculation that interest rates may rise? Why did sterling recover after the Bank of England’s decision?
- How has the recent speculation affected fixed rate mortgages?
- What does the Telegraph article about “savers’ celebrations on hold” mean about the ‘real value’ of money and savings?
- What are (a) the arguments for keeping interest rates at 0.5% and (b) the arguments for raising interest rates? Who wins and loses in each case?
- Are there any other government policies that could be used to combat inflation, without creating the possibility of a double-dip recession? Why haven’t they been used?
One of the interesting things about the recent recession was the dilemma that it posed for governments. As aggregate demand fell, unemployment rose, incomes fell, which reduced demand further and so national output began to decline. Obviously there were many other factors contributing to this decline, in particular the housing market, but the long and the short of it is, aggregate demand was falling. With the AD curve shifting inwards, we would expect the average price level to fall at the same time: i.e. inflation doesn’t tend to be much of a problem during a recession. It is this fact that posed something of a dilemma. In the recession, not only was aggregate demand low, but inflation was rising. The explanation for this: in large part due to rising commodity prices – a supply-side shock. Governments had to deal with low national output and inflation: this combination made policy changes much more complex.
While prices for many goods and commodities did fall significantly after their peak in 2008, there has been a gradual rise again and there seems to be no end in sight. Headline food prices, in particular, have increased almost to their 2008 levels, although in real terms prices are still lower. Onions in India; cabbage, pork and mackerel in South Korea; chillies in Indonesia – the list goes on. The rapidly rising prices of these basic foodstuffs has, in many cases, led to emergency government intervention. However, there are fewer concerns this time round, as many hope that the causes of these higher prices are not just the increases in demand but crucially temporary supply shocks. Bloomberg’s Businessweek Assistant Managing Editor, Sheelah Kolhatkar, said:
There are a lot of reasons [for rising prices]. Weather is cited as a big one. There’s been sort of freak weather in different parts of the world. Russia experienced a drought. There are floods in Australia. There’s been sort of freezing weather in Florida. Our own Midwest experienced flooding earlier this year. And because the market for a lot of these food commodities is global, when something strange happens somewhere, that can affect a crop.
On the other hand, there are growing concerns at the timing of this inflation: the developed world has barely escaped from recession. How is it that inflation can already be a problem? Furthermore, with loose monetary policy in many countries, rising food and commodity prices could continue for some time.
An interesting question to consider is which countries will be affected the most? In Britain, like other developed countries, food consumption accounts for between 15 and 20 per cent of a household budget. However, in developing countries, food can take up between 50 and 75 per cent of a houshold budget, so any rise in food prices is disastrous.
What does it mean for the recovery? Well, if food (a necessity) is increasing in price, households have little choice but to pay the higher prices. This means they have less disposable income for other goods, hence aggregate demand may be adversely affected. The following articles will hopefully give you some ‘food for thought’!
Articles
Soaring food prices cast shadow over trading Financial Times, Dave Shellock (14/1/11)
Next shock will be high food prices Sydney Morning Herald (17/1/11)
Commodities can still shock BBC News blogs, Stephanomics, Stephanie Flanders (13/1/11)
Many countries face catastrophe as inflation creeps up the food chain Independent, Hamish McRae (16/1/11)
Soaring demand soaks food oil reserves Sydney Morning Herald, Luzi Ann Javier (17/1/11)
Government to subsidise essential food items Sunday Observer, Gammi Warushamana (16/1/11)
Brace for higher food prices Jamaica Observer, Julia Richardson (16/1/11)
Jordanians protest against soaring food prices Guardian, Johnny McDevitt (15/1/11)
Inflation, the old enemy, is back. But this is no time to be frightened Guardian, Larry Elliott (16/1/11)
Global effort to calm food prices Washington Post, Steve Mufson (15/1/11)
The link between commodity prices and Monetary Policy Seeking Alpha (14/1/11)
Australian floods bost commodity prices, shares and funds Telegraph, Ian Cowie (13/1/11)
Soaring cost of oil and food will result in turmoil Belfast Telegraph Hamish McRae (18/1/11)
Q&A: Why food prices and fuel costs are going up BBC News (14/1/11)
Data
Commodity Prices Index Mundi
Questions
- What is the difference between headline food prices and real prices?
- What are the demand-side factors causing food prices to increase?
- What factors have affected the supply-side of the food market? Use a diagram to illustrate both the demand and supply-side factors.
- Can you identify some of the key differences between the causes of the rising food prices in 2008 and the rising food prices we’re seeing at the moment?
- Who are the winners and losers of rising food prices?
- What methods of government intervention are available to stabilise prices? Are they likely to be efficient and equitable?
- How is the exchange rate affecting food prices?
- Why could a loose monetary policy make food price inflation even worse?
- What are the main consequences of rising food and commodity prices? Think about the impact on different groups within society.
Two reports released by Incomes Data Services tell dramatically contrasting stories about pay in the UK. One report focuses on average pay in the public and private sectors, which are both likely to fall in real terms in 2011. Most public-sector workers will see a freeze in their wages and, whilst private-sector workers’ pay could rise by an average of 3%, this will still be below the rate of inflation. The press release Pay awards may rise but will trail inflation (6/1/11) to the report stated that:
Private sector pay settlements in 2011 could well be higher than in 2010, as long as the economic recovery remains on track. But following the latest increase in VAT, they are likely to trail inflation, meaning that the cost of living may be set to rise faster than average pay settlements for the second year running.
However, the press release to an earlier report, FTSE-100 bosses see earnings rise 55% (29/10/10), stated that:
FTSE-100 directors saw their total earnings boosted by an average of 55% while across the FTSE 350 as a whole total board pay went up by an average 45%, according to the latest Directors Pay Report, published by Incomes Data Services. (Year to June 2010)
On the back of these increases FTSE 100 chief executives took home £4.9 million on average in total earnings during the year.
Meanwhile, there is continuing public outcry over the levels of bank pay and bonuses. Despite billions of pounds of public money having been poured into banks to prevent their collapse, bank bosses are set to receive huge remuneration packages worth several million pounds in some cases. And, despite being condemned by the government, it seems there is little it can do to curb them.
So what are the causes of the growing income divide between those at the top and everyone else? And what are the economic consequences? The following articles explore the issues.
Articles: IDS reports
Year of pain predicted for workers.. while bosses’ salaries continue to grow Daily Record, Magnus Gardham (7/1/11)
Another 12 months of pay freeze misery for workers… but bosses enjoy a huge 55% salary increase Daily Mail, Becky Barrow (6/1/11)
Private-sector pay set to trail behind inflation People Management, Michelle Stevens (6/1/11)
Private pay deals to lag behind inflation Financial Times, Brian Groom (6/1/11)
UK boardroom pay rises 55% in an age of austerity Guardian, Simon Goodley and Graeme Wearden (29/10/10)
Private sector pay ‘to trail inflation’ in 2011 BBC News (6/1/11)
Staff morale warning over bosses’ pay rises Independent, Jon Smith (6/1/11)
‘Dose of reality’ call over top pay BBC Today Programme, Robert Peston, Brendan Barber and Garry Wilson (6/1/11)
‘Severe squeeze’ on average pay BBC Today Programme, Ken Mulkearn (Editor of the Incomes Data Services pay review) (6/1/11)
UK inflation rate rises to 3.7% BBC News , Ian Pollock (18/1/11)
Articles: bankers’ bonuses
Bank bonuses ‘to run to billions in 2011’ BBC News, (7/1/11)
Cameron says banks ‘should pay smaller bonuses’ BBC News, (9/1/11)
David Cameron warns RBS over bonuses Guardian, (9/1/11)
Banks say ‘no’ to bonus backdown Management Today, Andrew Saunders (7/1/11)
Banks to pay out billions in bonuses BBC News blogs: Peston’s Picks, Robert Peston (6/1/11)
Why government can’t stop big bonus payments BBC News blogs: Peston’s Picks, Robert Peston (7/1/11)
Diamond: ‘I am compelled to pay big bonuses’ BBC News blogs: Peston’s Picks, Robert Peston (11/1/11)
Data
Average Weekly Earnings Incomes Data Services
Questions
- Why are average earnings likely to be less than the rate of inflation in 2011?
- Why were the directors of the FTSE 100 companies paid an average 55% pay increase for the year to October 2010?
- To what extent can marginal productivity theory explain the huge increases of bosses of top companies?
- If remuneration committees base executive pay increases on the average of the top 25% of increases of equivalent people in other companies (to stop ‘poaching’), what will be the implications for executive pay rises over time?
- What market failures are there in determining executive pay?
- What will be the implications for staff morale if their earnings are falling in real terms while their bosses are receiving huge pay increases? Should these implications be taken into account when deciding executive remuneration packages?
- Are shareholders in FTSE 100 companies likely to welcome the pay increases of their top executives? If so, why? If not, why not?