04 - 07 - 08

As mentioned last month, one of the reasons that the economic data still do not support the Organisation for Economic Cooperation and Development’s gloomy view of the UK’s prospects is that employment remains strong.

Restraint is required of all of us

In addition, with the exception of a few sectors like oil delivery drivers who feel they can hold the country to ransom, even though they already earn substantially above the national average for what is not a particularly highly skilled job, wage inflation does not seem to be a significant threat, so far.

One reason for this is that, according to Professor Andrew Clare of Fathom Consulting, looking at data since 1990 shows that a 1% increase in consumer prices generally only produces a 0.2% increase in wages after about five years. (In Europe, the match is far closer and a lot quicker.) This makes wage-inflationary spirals less likely in the UK.

It can happen, however. So every one of us, employers and employees alike, need to be aware that inflation is bad for all; restraint needs to be exercised if we are to avoid it. Inflation invariably hurts the weakest individuals in society - especially pensioners, for whom there is no hope of recovering by earning more. But even workers are threatened, if higher costs force employers to make lay-offs. And even where this is avoided, workers will have to spend more in order to plan for their own retirement.

Mervyn King has warned that we face a “one-year pause” in the growth of living standards. He might be right – at best – and there is no reason why we should not be prepared to accept a little pain now, in the realistic expectation that things will get better. But we all have to act together.

Economic growth slows
Gross Domestic Product (GDP) grew by just 0.2% in the three months to May, compared with 0.4% in the three months to April. While some commentators claims that this is likely to tame inflation, it is also worth noting that the factors which have previously helped to keep inflation under control are no longer as prevalent.

Rising oil prices could slow globalisation

For example, the growth of China and India as producers of cheap exports throughout much of the past decade has helped to keep UK inflation in check. However, internal demand is likely to expand in these economies, forcing up prices and reducing the benign impact they exert on our markets. What is more, rapidly rising oil prices could well slow down the process of globalisation as transport costs become prohibitive; either UK prices for Chinese goods will rise, or exports from there will slow down.

Inflation in the UK may have hit 3.34% (using the government’s favoured CPI) or 4.32% based on RPI (which is of greater interest to those with deferred defined benefit pensions) but in Europe the CPI figure is 3.7% and in the US4.2%. Overall, there are still positive signs in the UK. If we hold our nerve, we could ride out the storm. Few people expect rampant inflation here.
 
Government borrowing
One lesson we all need to learn from recent events is that, as a nation, we need to exercise more self-restraint. Thanks to some positive thinking from Gordon Brown when he became Chancellor in 1997 (particularly in setting the Bank of England free to manage interest rates) we have enjoyed more than a decade of stable, low inflationary growth.

Even George Bush had room for manoeuvre

Unfortunately, this has all been squandered by unfettered government spending, based largely on borrowing. This means that while other economies are enjoying health surpluses – or at least relatively small deficits – our borrowing has been estimated to be 43.2% of GDP, against a “safe” target of 40%, when Northern Rock is taken into account. This means that there is nothing in the kitty for us to use for a recovery; unlike the US, where even George Bush has been able to fund a mini spending boom by giving back $150 billion in tax rebates.

Individuals cannot simply blame the government, however. Figures from the Office for national Statistics show that the average family now owes a record 173% of income; this is way up on the 129% figure of just five years ago and the highest of any G7 country.

Markets (Compiled by the Insurance Marketing Department Ltd.)
If ever we needed proof that investments should be viewed over the longer term, this month provides it in abundance. Although not the largest single-month fall this year, the FTSE100 lost -7.08%, dropping below the 6,000 mark again. For those thinking this index shows all the characteristics of a yo-yo, we agree! But then so are the others, with the FTSE250 losing almost -9% this month, the Dow Jones -10.19% and the Eurostoxx50 a massive -11.25%. In fact star performer of the indices we track was the Nikkie225, which ‘only’ lost -5.98%.

Long term performance

Taking a slightly longer view, the FTSE100 is only down by 1.34% over the last three months and the Dow Jones is actually ahead by almost half a percent. The twelve month figures are far less encouraging, but even this is too short a time scale to look at equity markets. If we look at the index over five years, we see that it has grown by a respectable 42% and has for most of that time been above its own average performance. This suggests that a correction was on the cards … and has certainly been experienced.

One thing that has not suffered over the past month is the price of oil, which has gone on to new records ending the month 9.81% up at $140.31 a barrel for Brent crude 1-month futures. The US dollar lost ground to sterling and the euro, last month, with the pound almost back to the $2 mark and the euro heading towards $1.60.

House prices fell by 0.93% during June, according to Nationwide, which represents a 6.3% fall over the past year, compared with a 4.4% fall year-on-year to the end of May. A good time for anyone wishing to ‘trade up’?

Interest rates
After considering an interest increase, the Bank of England’s Monetary Policy Committee voted 8:1 against any change, in case a cut spurred inflation or an increase damaged industry.

When it comes down to it, of the 1.2% rise in inflation since last December, 1.1% of it is down to food and fuel. A little belt tightening could help us survive and even lose weight – less food, more exercise!

Monetarists, whose most famous apologist was Milton Friedman, have taken the opportunity to warn that with M4 (the widest definition of money supply, rather than the quickest way to Wales) slowing dramatically, corporations have less cash in the bank, which will constrain their liquidity, exposing them to potential dire consequences, should the credit crunch continue for long. This group of economists are, however, in the minority.

It will be interesting to see what happens in the Eurozone, where the French, Italians and Spanish appear to be at loggerheads with Germany. The northern state wants to see interest rates rise but, for largely domestic reasons, the southern states do not. A recent almost un-diplomatic spat could see the “doves” gang up on the lone “hawk” – which is provided for under the Maastricht Treaty.
 
Why are oil prices rising?

Scarce resources need to be husbanded

Many commentators have suggested that much of the recent spike in oil prices is down to speculators. Apparently even G8 (that is G7 plus Russia) ministers cannot agree on the cause, some citing the fact that airlines have been forced to hedge against future price rises, just as much as speculators. One thing is clear; world output of oil fell by 0.2% last year, while consumption rose by 1.1%.

With China, India and other ‘new’ economies having an increasing appetite for energy, we can expect prices to continue to rise unless output increases significantly. The problem is, of course, that greater use of carbon fuels leads to global warming so alternative forms of energy are urgently needed. And with the UK moving from being a net exporter of oil from 1981 to 2003, to being a net importer today, we have a vested interest in moving forwards on this front.

Unfortunately, the wealthy and powerful oil companies do not share common cause with the rest of us. Could this be why BP is telling us that the real problem is high taxes being a bar to new entrants into the market?

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