The new Chancellor Philip Hammond, in case you hadn’t noticed is due to deliver his first mini-Budget, more formally known as the Autumn Statement, in just a few weeks time on November 23. As these things go, there seem to have been remarkably few hints or leaks as to what might be in it. In fact so few, that some cynics are wondering whether he’s going to simply make it up as he goes along on the day, much like other government policy since July.
More likely is that the economic background is currently so changeable almost day-to-day that the Chancellor (along with the Treasury and Bank of England) really has to tread extremely carefully, and adjust any plans almost continuously right up to the day itself.
Take one example. Just a year ago the UK economy, along with others in Europe and the US, looked set to dip into deflation falling retail prices with the clear implication that this could become the new norm. In the past few months however, here in the UK, we’d already started seeing warnings of a return to inflation. Then the ONS published the official inflation figure for September as 1% the highest month-on-month increase since June 2014, and the highest monthly rate since November 2014.
One of the key reasons for the sudden jump was, of course, the price of fuel. A year ago prices were falling, but as every forecourt retailer (and driver) has noticed, recently pump prices have been rising almost every week.
There is an equation that describes the precise relationship between the price of crude oil and the pump prices of petrol and diesel on your forecourt. It’s quite long, contains many variables and mathematical operations, and unfortunately can’t be reduced to anything catchy (like E=mc2 say). The closest and very rough equivalent that some retailers like to use informally is that the pump price (in pence per litre) is approximately equivalent to 2.5 x the crude oil price in $US. So a crude oil price of $40/barrel equates to a retail price of around 100ppl. While that may be true at particular times, it’s not really very accurate in the longer term, which is probably why even the popular media haven’t latched onto it.
But a real pricing equation does exist, and is used in one version or another every day by the oil companies when they’re setting your next delivery price.
And, of course, two of those many variables are the price of crude oil and the pound-to-dollar exchange rate.
In the past few months both of those key variables have been varying rather frequently, in some cases quite dramatically. Take the exchange rate. As a few unlucky Brits buying foreign currency at their departure airport found to their cost in October, the pound was, at that point, buying less than one euro, and more-or-less one US dollar. Of course, those were retail exchange rates (and particularly unattractive ones), and the official rates weren’t that bad, but if nothing else they do point to what may become the norm in a few months time.
While admitting that the relationship between crude oil prices and retail pump prices is a complex one, combine the effects of a rise in crude prices (from say $40/barrel to $50/barrel) with a fall in the pound-to-dollar exchange rate (from say £1=$1.45 to £1=$1.10) over the same period, and the result is for want of a better word volatile. An increase of 25% in dollar prices results in an increase of 32% in pound prices.
And that’s what we’re seeing at the moment. It doesn’t apply only to oil of course.
The relationship between the world price of wheat and the cost of a loaf of bread in the forecourt shop is almost as complex as the one between crude oil and petrol but what they have in common and what applies to almost all commodities is that the key prices are set in US dollars. And if pound sterling continues its decline towards parity with the US dollar (or below) we’re going to see not just inflationary price increases, but more volatile price movements whenever commodity prices change. Hence the continuing background rumbles emanating from the Bank of England ever since the end of June warning that inflation is likely to become an important factor in economic planning over the next year or two.
The 1% figure in September may have felt quite dramatic when it was announced, but in reality and in a historic context it’s not much.
However, the Bank is already warning that figures in excess of its benchmark or target rate (2.5%) are likely in the next 12 months.
Quite where that leaves the Chancellor and his Autumn Statement is something that we’ll only find out on the 23rd.
Over the past 35 years or so, the first tool that every UK government has reached for out of their economic toolkit has been interest rates; and while those are currently at an all-time low (here and in most of the world) there will be a natural tendency to look at them and see an ’obvious’ route of strangling inflation before it takes off.
However, as we’ve all seen since 2008, there are many reasons why interest rates have had to stay so low for so long.
Every government has been terrified of what increases might do not only to growth but to the financial/banking sector that we (ie the tax payers) bailed out at such great expense just a short time ago.
And, of course, any decision involving interest rates in the UK has knock-on effects elsewhere the US and Eurozone to name just two places and on the price of government borrowing here in the UK, so it’s not one that the Chancellor can take too lightly.
Where that leaves Mr Hammond and his Autumn Statement is something we’ll find out on the 23rd. Interesting times indeed.