MNI INTERVIEW: Price Data Imply UK Inflation At Turning Point

UK inflation has hit a turning point and falling prices may not be as sticky as some fear, a former Bank of England economist told MNI, although he noted that policymakers are still right to worry that the high inflation the country has experienced could become self-reinforcing.

Richard Davies, who has also advised the Treasury, tracks tens of thousands of prices of individual goods and services and also links price data to trade data Through such detailed monitoring, he finds that, typically, the number of price rises and falls each month came close to balance until the onset of the war in Ukraine, when rises started to heavily outstrip falls. However, a narrowing in the gap between price rises and falls can be detected in the latest figures, according to Davies, although there is evidence that services prices are less flexible downwards.

"There is a bit of a turning point ..This new thing that we have seen, which is that it is much more common to have price rises than price cuts, is still there (but) the very latest data point shows it is coming down," Davies said.

WHAT GOES UP…

The encouraging feature in the data, with Davies’ work cited by current BOE Monetary Policy Committee member Swati Dhingra, is that firms have historically not been less likely to cut than hike prices.

"There was an old school idea that goes back to Keynes that prices would be sticky downwards. That is very much not the case. There's just no real evidence that there's any stickiness downwards," Davies said.

The research does find however that prices of services are stickier than for goods, reflecting the intuition that the prices of, say, haircuts or a plumber’s hourly charge changes infrequently.

Research is also being done on how an ageing population, such as the UK’s, spends more on services than goods, making prices less flexible.

FEEDBACK LOOP FEARS

The risk is that the high inflation that the UK has been experiencing becomes self-reinforcing.

"The ultimate question .. is the extent to which, and this is the challenge which the Bank faces, but also the Fed and everyone else, these patterns create any kind of feedback loop," Davies said.

The inflation shock could see a pattern where "prices start rising because prices have risen, rather than the more fundamental point about the actual scarcity of supply," Davies said, adding that "the key question is just how much inflation becomes embedded."

The UK historically did not have a strong record on avoiding self-reinforcing inflationary patterns although this has changed as the Bank of England and the Treasury “worked very hard to create a reputation and an expectation and the delivery of low and stable prices," Davies said.

BREXIT PREMIUM

Another strand of Davies’ work has linked price and trade data and suggested that Brexit, with the new trading arrangement with the EU adding non-tariff barriers, had added to UK inflation.

The research looked at the exposure of individual goods to EU markets, their trade intensity, and found that whereas previously all products had similar price trends after Brexit there has been a significant relative increase in prices for products with higher EU exposure.

"There is a clear and quite strong relationship there," Davies said.

The analysis, published in May, found that between December 2019 and March this year food prices rose around 25 percentage points, and this would have been 8 percentage points less in the absence of Brexit.