Research Dept. News
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Monthly Report, num 285 - November 2005
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Economic situation
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Fears of inflation
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Consumer price indices show considerable rise in September setting off alarm in central banks.
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October was marked by some alarm due to inflation. During the month, as consumer price indices for September became known, they showed a sharp increase in prices of oil by-products. The CPI figure for the United States went from a rate of 3.6% in August to 4.7% in September, a level not reached since July 1991. In the euro area, the harmonized index moved up from 2.2% to 2.6%, the highest rate since January 2002. In the main countries of the euro area, including Spain, year-to-year rates added between four and five decimals to that for August.
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The central banks are concerned. One of the biggest successes of the recent decade in terms of economic policy has been disinflation, that is to say, the decrease in inflation rates to low levels. Measures taken by the central banks in a context of independence from their respective finance ministries, has been a key in this matter. Following an 80% rise in raw materials prices in the last four years, however, those responsible for monetary policy face the risk that inflation expectations will move up. This would give rise to increases in prices and wages more than desirable with the risk of unleashing an inflationary spiral, which was the nightmare of economic policy in the Seventies and Eighties.
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If inflation expectations increase, rise in oil prices will likely spread to other prices in economy, including wages.
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If we are to go by the performance of core inflation, these figures may be considered exaggerated. That is to say, if we deduct from price indices the more volatile components, normally food and energy, in order to observe the more stable component, we find that both in the United States and the euro area inflation stands at low levels. In the first case, core inflation is running at rates somewhat above 2%, a higher level than the lows seen in 2003, when it scarcely went above 1%, but acceptable from a mid-term perspective. In the euro area, core inflation stands at a very low level (1.5%). Therefore, the jump in oil prices has not shifted to other prices. From this point of view, we are not lodged in a period of general price increases which is what we understand as inflation.
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While core inflation holding stable in context of growth or recovery, shift of price increases in raw materials becoming easier.
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We know, however, that the shift in the rise in oil prices and prices of other raw materials to the core of inflation, when it does happen, takes place slowly. We also know that in a context of strong growth, as is the case in the United States, or at the beginning of recovery as we believe is taking place in Europe, it is easier for the increase in raw material costs to affect other final prices or wages. Those in charge of the central banks are doing well to protect us from inflation risks.
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The first measures adopted have been warning statements. Members of the Federal Reserve, the Bank of England, the Bank of Switzerland and the European Central Bank (ECB) have considerably toughened their monetary stance. Other central banks have opted for directly raising their reference rates, as in the case of South Korea and Canada.
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Ben Bernanke, who succedes Alan Greenspan in February, to inherit tightest monetary policy since days of hi-tech bubble.
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In fact, for more than a year the Federal Reserve has been raising its reference rate at each meeting of its Monetary Committee. It will continue to do so in spite of the impact of the hurricanes in August and September which at first raised the possibility of a halt. In fact, the US economy is not showing any sign of moderating its growth. This was stated in the latest issue of the Beige Book, a document published by the Fed eight times a year just before the meetings of the above mentioned committee. Some problems were seen only in those areas affected by the hurricane devastation. Ben Bernanke, who takes over from Alan Greenspan as president of the Fed in February, will inherit the tightest monetary policy since the height of the hi-tech bubble at the end of 2000.
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In euro area, markets anticipating rate increases by European Central Bank in coming months.
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In the euro area, the ECB is holding up, still maintaining its reference rate fixed at 2% since June 2003. Up until quite recently, pressure, both from private interests and from the International Monetary Fund itself, was in favour of the ECB lowering its rates even more in order to consolidate recovery. Now, fear of inflation is more pressing and the markets are already discounting rate increases in coming months. The euro area, however, must still show that economic recovery is actually taking place. Some signs of this improvement may be seen in industrial production, in passenger car registrations and in retail sales. Employment, however, is scarcely growing and furthermore we note weakness in foreign demand which up until now has sustained the scarce progress seen in the EU as a whole.
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Inflation also a problem in Spain
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Alarm in Spain as inflation also shows considerable rise in September because of oil prices.
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Spain also has had its own inflationary scare. The consumer price index (CPI) showed a sharp increase in September which put the year-to-year rate at 3.7%, the highest figure since 2003. The cause of this was the fuel and fuel-oils group which together brought a rise of 22% so far this year. Also contributing to the monthly figure was the performance in some fresh foods and the government decision to raise taxes on alcoholic beverages and tobacco, a measure aimed at obtaining funds to finance the deficit generated by public health.
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This is not merely a temporary situation. Inflation is turning into a headache coming on top of the anxiety caused by the unstoppable foreign deficit. The Ministry of Economy openly admits that the year will end with a CPI very close to 4%, twice the official objective. The blame lies with the per barrel price of oil. If we remove the increase in fuels from the index, we may consider that inflation is holding at a more or less stable rate. In October, the price of crude oil tended to moderate which raises a ray of hope. The Ministry of Industry has requested the oil companies to narrow their business margins and to encourage the use of renewable energy.
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The government, however, has little margin for manoeuvre. In October, the situation in the energy market made it necessary to authorize an increase in gas tariffs of 6% for domestic consumers and 18% for industry. Bottled gas also rose in October for the third time this year. On the other hand, the drought is slowing production of power at hydro-electrical stations and it is necessary to burn more oil to produce the same power levels so that government is studying the matter of raising electrical tariffs for the first time in nine years.
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Higher than expected CPI means automatic rise in pensions and wage increases due to step-up clauses.
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All of this is contributing to increase fears that the rise in energy costs will spread to other prices in the economy. Wage-indexing mechanisms which exist in Spain’s economy are still very strong. The excess in the CPI will automatically bring about a complementary increase in government pensions with a cost estimated at more than one billion euros. In addditon, most collective bargaining agreements contain automatic step-up clauses covering the situation where inflation goes above the official objective so that the effect of oil prices on wages is inevitable.
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Truck-driver strike spreads fuel increase to other goods and services.
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The increase in fuel costs has brought about protests by certain groups which feel directly affected. For some days in October, truck-drivers coming under the largest operator group in the sector stopped their trucks thus having a notable effect on supply to factories and retail outlets. The stoppage was called off following agreements between the truck-drivers and the government, which involved a slight reduction in fuel taxes paid by the sector, as well as other advantages, and agreements between truck-drivers and loader organizations who accepted a rise of 14% in rates. The example spread further afield. Fishermen began a strike aimed at lowering the cost of diesel fuel while members of some farm organizations also carried out demonstrations.
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Negative real interest rates brings continuation of spending spree.
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Higher inflation means lower consumer purchasing power. However, if consumers manage to recover lost purchasing power through the indexing clauses mentioned above, spending pressure could increase the risk of inflation. Furthermore, if monetary conditions do not compensate these pressures through, for example, an increase in interest rates, the situation becomes more complicated. At this time, yields on Spanish government bonds of whatever term stand below the 3.7% inflation rate. Only 30-year bonds are showing a yield of 3.75% in the secondary market. With negative real interest rates, companies and households continue to borrow at very high levels. And they continue to spend. There is no halt to consumption. It seems that the increase in fuel prices is being ignored by car owners given that car sales are moving ahead firmly beating all-time highs.
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National Reform Programme suitable instrument over medium term but fails to solve more immediate problems.
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If we are to go by the 2006 central government budget now under discussion in parliament, government measures will not contribute to cooling off consumer spending or investment. However, at least we should point out the presentation of the National Reform Programme which perhaps has not received the attention it deserves. This is a move which comes under the so-called Lisbon Agenda, a plan for European Union measures aimed at ensuring that the EU does not fall behind the more dynamic world economies. The Programme sets out a broad range of measures to improve income, productive capacity and efficiency. This is surely the way to remedy existing imbalances over the medium and long term. Over the short term, however, it will be necessary for all those involved in the economy to be aware of the times in which they are living so that small individual gains today do not mean widespread losses tomorrow.
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Cronology
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CRONOLOGY
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2005
| February |
2 |
Federal
Reserve
raises
reference rate by quarter point to 2.50%. |
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25 |
Government
approves Economic Potential
Plan, broad programme of
economic reforms aimed at increasing productivity and employment (BOE 14-3-05).
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| March
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4 |
Dow
Jones index for New
York stock exchange marks
up annual high (10,940.55), a rise of 1.5% over end of 2004. |
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22 |
Federal
Reserve raises reference
rate by quarter point to 2.75%. |
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23 |
Heads
of state and government of European Union member states approve reform of Stability
and Growth Pact introducing
more flexibility. |
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| April
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20 |
Dow
Jones index for New
York stock exchange marks
up annual low (10,012.36) with 7.1% drop compared with end of 2004. |
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| May |
2 |
Cypriot
pound, Latvian
lat and Maltese
lira join Exchange Rate
Mechanism. |
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3 |
Federal
Reserve raises reference
rate by quarter point to 3.00%. |
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| June
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30 |
Federal
Reserve raises reference
rate by quarter point to 3.25%. |
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| August
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9 |
Federal
Reserve raises reference
rate by quarter point to 3.50%. |
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| September
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1 |
One-month
forward price of Brent quality oil
goes up to all-time high level of 67.48 dollars a barrel. |
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17 |
Increase
in special taxes
on alcohol and tobacco to finance health (BOE 17-9-05). |
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20 |
Federal
Reserve raises reference
rate a quarter point to 3.75%. |
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| October |
4 |
IBEX
35 index for Spanish
stock market marks up annual
high (10,919.2), a cumulative gain of 20.2%. |
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13 |
Government
aproves National Reform
Programme for Spain.
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Agenda
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AGENDA
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November
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1 |
Meeting
of Federal Reserve Open Market Committee. |
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3 |
Meeting
of Governing Council of European Central Bank. |
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4 |
Industrial
production index (September). |
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14 |
Preliminary
Quarterly National Accounts (3rd Quarter). |
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15 |
Consumer
price index (October). |
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16 |
Harmonized
consumer price index for European Union (October). |
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22 |
Central
government revenue and spending (October). |
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23 |
Quarterly
National Accounts (3rd Quarter). |
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25 |
Producer
price index (October). |
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29 |
Early
HCPI index (November). |
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30 |
GDP
for euro area (3rd Quarter). |
December
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1 |
Meeting
of Governing Council of European Central Bank. |
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2 |
Industrial
production index (October). |
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13 |
Meeting
of Open Market Committee of Federal Reserve. |
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13-18 |
6th
Inter-ministerial Conference of World Trade Organization. |
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15 |
Consumer
price index (November). |
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15-16 |
Meeting
of European Council. |
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16 |
Harmonized
consumer price index for European Union (November). |
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20 |
Central
government revenue and spending (November). |
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21 |
Quarterly
survey of labour costs (3rd Quarter). |
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22 |
On-going
survey of household budgets (3rd Quarter). |
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26 |
Producer
price index (November).
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