Bank of England Inflation Report November 1993 Inflation Report November 1993 SUlllllHlry Recellt price developments 5 1.1 Rclnil prices 5 1.2 Output prices 6 1.3 Domestic defl ators 8 1.4 'Core' inflation 8 1.5 Summl.lr), 9 Box Rebasil/g and H ' I'iJioIlS- IIOII' /ias hisrOlY changed? 7 2 j\lonehlr~ and fi scal policy 10 2.1 MOnChlr)' conditions 10 Interest rates 13 Exchunge nltc:-; I ~ 2.2 Fiscal policy I ~ 2.3 Sumll1:u')' 15 Box MO \ /IIollitoring ral/ ~e 12 3 Demand and oulput 17 3.1 Ocmand 17 Personal spend ing 17 Investment and stockbuilding 18 Overseas trade 20 3.2 Output l.md the outlHlt g.lp 22 3.3 SUm lmlr)' 24 Box CSO rnule figllres: I/e ll' colleCTioll methods 21 Box UK comperiril'elless 23 4 The labour market 4.1 Earnings :tnd settlements 25 4.2 Eml)loymenl and unemployment 25 4.3 Labour produclivit)' and unit wage costs 27 4.4 SUlllnll.lry 28 5 Price dynamics 29 5. 1 External inrluences 29 Pri rnary product prices 29 Overseas inflation and im port prices 30 - ,.-, hllHlt prices 30 5.3 Uusincss prolih,bility 31 5.4 Summary 33 6 Pmspccts 1'01' inflation 34 6. 1 E,'id cncc from timllldal markets 34 6.2 Pri".ltc sector forecasts 34 6.3 Survc~' s of inflation eXI}cctations 35 6.4 Bank projections 36 The shorHun out look 36 Longer-term projections 36 Uncertainties 38 7 Conclusions 39 Re,,"nl~d f,om 11", N,)\~",I>,'r I<)IJJ Il:on~ "' Engla"J Q,,,,,.,n-/, /1"1/,.",, 1'"IIlcJ b} ll" rrHp' Lld. SI 'vc, plc Cl I l:I,,~ " I I' ''gl;o "d 1';<)1 ISIlN I H57.1() (JJ2 4 Summary The illjJmioll Report cons i dc r ~ recen t dcvcloplllcnb. in inflation an d puts forward the Bank of England"s all a Jy~i~ of future prospects. [\ corllain s seven sections covering: (i) recent price developments: (i i) monetary and fiscal policy: (i ii) demand and output: (iv) the labour market: (v) pri ce dynamics: (vi) the prospects for inflation: and (vii) conclusions. Underlyi ng inflation- defined ilS the \wclvc-momh c han ge in the Rel.\i! Prices Index cxclu dlllg mortgage interest paymenb (RPIX)-has risen si nce the last 11I{(tllioll Report. I! was 2.89'(' in June. but has increased in each of the la~1 three Illonth~. (0 reach 3.3% in September. The headline rat e of inflation has abo ri sen. RPI X inflation has heen affected by the ~wilC h fromlhc Community Charge to the Council Tax. To disentangle the impact of such tax changes on the price /{".", from the 'underlying' rate of illJ/(I{ioll. it is useful to examine a price index which exclude~ not only mortgage in tere",t payments but a[",o indirect taxes and local authority taxes. Inflation mca~ured in th i", way ro~e from 2.8q. in June to 3.5% in September. the same as a year ago before sterl ing's depreciation began to affect import pri ce~. Some increase in inflation between June and September had seemed likely at the time of the last Rt,porI. Sales discounts wcre unusuall y widespread in June. !:!uggesting that a ri!:!e in the inflation rate would fo ll ow post-sale price rises. In addition. seasonal food prices fell by more than is usual in JUlle. In fact. RPIX inflation has risen a liule more than projected last time: to 3.3% compared with 3. 1%. Th is difference partly refl ects sma ller than expectcd falls in food prices in Jul y, and partly the larger than expected recovery in the prices of household goods and clothing and footwcar associated with the end of the summer sales. To conduct monetary policy effectively, it is necessary to form a view aboul the likely course of inflation over the longer term. Given current policies. Ihe Ba nk's vicw of lhe most likely outlurn is Ihal inflation- both hcadline and RPIX-will ri se untillhe middle of 1994 and then start to decline again . The new information avail'lble since the August Report has led to a small upward revision in Ihe Iwelve-month inflation 1"<1I es expected over Ihe nex l few mont hs. but it has nOI prod uced any signi ficant change to the expected rat e of inflation Iwo years from now. The central projec ti on remains with in the target range for RPI X inflation. BUI there is a slight possibility that in the first ha lf of next year inflati on wi ll brie fl y rise above the top of the target range. Th is is panly because of changes in indirect and local au thority taxes. Excluding those taxes. inflat ion is expected to start f'llling in early 1994. and could reach a level close to the middle of the target range in 1995. But there arc considerable uncerwi nties. The fi rst concerns the exchange rate. If attempts to stimulate recovery lead to bi gger than expected cuts in in terest rates abroad. this would be likely to push up the sterl ing exchange rate and reduce inflationary pressures in the short run. A second source of uncertai nt y is the behaviour of wage bargainers. If the short -ruIl increase in infl ation is simply extrapolated forward and earnin gs start 10 rise more rapi dl y. then more of the growth of nomi nal demand whi ch is expected over the next year or two will take the form of higher prices rather than hi gher output and empl oyment. But Ihe continuing output gap. moderate growth of nominal demand. and slow growt h in broad money and credi t. all po int to the possibility of bringing in fl at ion down fu rt her at the sallle time as output growth picks up. Recent price developments 1 l.l Retail prices Underlying inflation- defined m. the twel ve-month change in the Retail Prices Index excluding mortgage in terest pay ment s (RP IX)- bas ri sen ~ince the last Chart 1.1 /njl(l/ioll Report. It was 2,8 % in June bUI has increa:.ed Inflation in each of th e last three months to reach 3.3% in September (Chart 1. 1). The headline rate of inflation has also risen. Three mOllth s ago it had fallen to 1.2%. Ihe lowest rate for nearly 30 ye'lrs. but by September it had increased 10 1.8%. Headli ne inflation has been lower than RPIX inflation since the middle of 1991. The difference between it and RPIX pri marily reflects changes in mortgage interest payments d uring the prcv i ou~ twel ve mon th ~. The gap wi ll narrow in thc ncxt fcw month ~ a:-. the reduction ... in interest rates which took place la:-. t aulumn fall out of the twelve-month calculation. Du ring the coursc of thi s year. RPIX inflation has been '" 11 .... ,."""","-"«1",, "". ...... ," '"' v ... ·, ..... , ,,,,,., ..... 1 ..-"' ..... NI', affected by the switch from the Community Charge to """"' ..." . the Council Tax. The c han ge lowered the twelve-month ri se in RPIX. an e ffect whic h will persist until the second quarter of next yea r. At th at point the increase in VAT announced in the M,lrch Budget wi ll enter the index. To disent angle the impact of such tax c han ge~ on the price lel'e! from the 'underlyin g' rate of ;lIf/alioll. it Tllhlc I.A is useful to examine a price index which excludes not Contrihulinlls to HI'IX inllalion onl y mortgage interest payments bu t also indirect laxe:-. G,.",h 01 "h"'h S«'k"" C""",,,I I(I'IX,,, (VAT and excise duties) and local authorit y !;lxes. Sc~"M,.1 CIooh,"$ Tu (",od, and Chart I. I shows inflation measured in thb way­ f. _ " ,, ~ .. denoted by RPIY- since Ihe beginning of 1990. RP] Y Se", IW ~ 1 62 ·0 11 ·01)2 O .~l ~. O M", 1991 I n .(1 16 0 02 O ~\ J~ inflation rose from 2.8% in June to 3.5% in September. Junt I99J I ~~ I) 10 ·(P O ~ 8 x'" 199' I <15 I) I1 I) I ! ·(n o .H the same as a year ago before sterl ing's depreciation .., 1'<"" ...,.,"-""".) .... , .. ,.... began to affect import price:-. C._ ... ,""') ... ",m •• M'" "" ...... ".......... ' _<or"'''Iuo,. ,• ., ' ~, I .. _h ""n.oJ Some incrcase in both RPIX and RPIY inflatio n between June and Septcmber had seemed likely al the time of the last Report. Salc:-. di ~Cot lllt s were unusually widespread in June, particularly fo r c lothing and footwear, suggesting Ihat a ri se in the inflation ralC wou ld foll ow post-sale price rises. In addition. seasonal food pri cc~ fe ll by more than i~ usu:ll in JUlle. Table I.A shows thallh c~e two f:lClors accounted for most of the ri se in inflation between June and September. Short-run infl ation measures can often give an earl y indicatio n of a change in inflation. Table I.B shows the three-month in fl ation rates for a number of indices. The fi gures have been seasonally adjusted and annualised, to Tahll' I.n allow comparison with conventional twel ve-month Shurl-rul1 nH.' a~III· I" of inl1aliun mcasures. Short-ru n measures need to be interpreted I'",,,,,,,"~" ,ha,,~", ", with particular care in o rder to distinguish changes in the RI'I NI'IX RI'I) normal seasonal pattern (such as the early start of \'1',",,,1>0, I 'J'J! ! ~ l" I .! 4,~ summer sal es in Ju ne), from persistent c hanges in the D.