Chris Giles Confident King and a load of foody nonsense

Two interesting tidbits on inflation today.

First, at the Treasury Select Committee this morning, Mervyn King, Bank governor said he had essentially defeated Britain’s inflation problem.

“The projections that we published in the inflation report a couple of weeks ago have the characteristic that the inflationary pressures are pretty much back to target by around the middle of this year.”

To show this requires a bit of simple statistical manipulation of the Bank’s latest inflation forecasts and the application of the most simple seasonal adjustment techniques to the quarterly inflation data to get the following chart. It is very similar to one published by David Miles, MPC member,  in his speech last week (when I was on holiday) which uses more sophisticated seasonal adjustment.

The idea of the chart is rather neat because it shows both the big spike in prices households are feeling right now – around 7 per cent this quarter at an annualised rate – and that the Bank’s central forecast shows the inflation problem disappears by the third quarter of the year. The 2008 oil price spike, 2008/9 fall in VAT rates and subsequent rises in 2010 and 2011 are also clear to see.

Second, there seems to be some confusion about the economics of competition when it comes to food prices.

Much of the media went quite heavy on a UBS report yesterday which warned that UK supermarkets might be on the verge of another competition inquiry because food price inflation has been higher in the UK than in other European countries. Though this made for good rip-off Britain headlines,  rapid pass-through of food commodity price rises is more consistent with a competitive retailing sector than one that lacks competition.

The simple rationale for this is that under perfect competition, any cost increase has to be passed on in full to consumers, since retailers would not have any margins with which to cushion any cost rises.* Countries with less retail competition would have retailers with excess profits able to soak up some of the rise in costs (at least initially) and food price inflation would be lower even though the price of food would be higher.

Other than a simple levels versus changes confusion, it might be the case that British supermarkets have used the opportunity of rising wholesale food prices to increase their margins, but that would simply raise the question why they felt unable to benefit their shareholders at the expense of consumers before commodity prices started to rise. Higher food price inflation in Britain is most likely to signify that food prices in the UK are low but are rising proportionately faster than in continental Europe. Anyone who has spent last week in France would have a bunch of anecdotes to back this up.

*The ultimate price might not rise accordingly because of a greater than zero elasticity in the aggregate demand for food.  I will now stop the descriptions of my A-level economics course.