Why the UK inflation risk after lockdown is hard to assess

 https://www.ft.com/content/6925a0bb-f233-4a86-8556-6d03dee23dc0

Terry, who repairs bicycles in a basement workshop in north London, has been working flat out since recovering from a month-long bout of Covid-19 in January. The lockdown bike boom shows no sign of slackening. With manufacturers unable to meet demand, second hand prices have risen, he thinks, by 15 to 20 per cent and people are coming to his Underground Bicycles with old frames that would usually not be worth repairing. The market for spare parts has also “gone crazy”, he said, with some generic components all but unavailable in the UK, let alone their more reliable branded versions. “I just got 20 seven-speed freewheels . . . I paid double what I would have liked to.” Cycling’s soaring costs is one of many instances where the pandemic has fuelled consumer demand, disrupted supply chains and made it harder for businesses to operate, pushing up consumer prices. The question now is whether broader inflationary pressures will build as the UK economy reopens — with many consumers ready to spend amassed savings and many businesses still unable to operate at full capacity. So far, price rises have been patchy. Haircuts cost more after salons reopened last July, besieged by customers but burdened by personal protective equipment costs and social distancing requirements. Remote working appears to have driven up prices for data processing equipment. Second hand cars are selling for more because supply is down, with people delaying replacing their vehicles. But these have been balanced by similarly sharp price falls in areas where demand has slumped — for office clothing, women’s shoes or, Office for National Statistics data reveal, pregnancy tests. Research published by the London School of Economics shows that prices have been more volatile in the past year than at any point in the last 20. But the measure of consumer price inflation targeted by the Bank of England stood at just 0.7 per cent in January, even after adjustments by the ONS to take account of the way lockdowns have skewed spending. Now, the dynamics are changing. Andrew Bailey, Bank of England governor, told the BBC on Monday that inflation would start to rise towards the central bank’s 2 per cent target in the next two to three months, but that he saw “no evidence” to suggest it would rise to the 4 or 5 per cent level that could threaten price stability. Andy Haldane, the BoE’s chief economist, however, warned last month that in future inflation could “behave very differently than in the past”, and in the UK could overshoot its target for a sustained period, proving hard to tame. “It does feel as if the risks are shifting towards the upside,” said Paul Dales, of consultancy Capital Economics. He argued that higher global prices for oil, agricultural commodities and shipping could help push UK inflation above 2 per cent by year end. But these effects will be temporary, and offset by a stronger pound curbing import costs. The real issue is how far spending surges as restrictions ease, and how far companies are able to meet demand without raising prices. People are already paying exorbitant prices for holiday lets while some pub gardens are booked out for weeks after their earliest possible opening date in April. Wedding venues will probably be able to name their price when couples are finally able to marry. “We will see some extraordinary price increases at the top end,” said Richard Davies, economics professor at Bristol university and author of the LSE research, adding: “I normally go once a year to watch Wales play in Cardiff. I’m happy to pay £100. Now . . . I’m probably prepared to pay £200.” But both Davies and others think such price spikes will be shortlived. In a weak labour market, wage growth is unlikely to be strong enough to create lasting price pressures; and workers on low incomes — who are more likely to spend spare cash when they have it — are not the ones who have built up savings over the past year. “There will be lots of business out there who will feel the need to keep price hikes modest to get people through the doors,” Dales said. “How many haircuts can you have?” asked Sandra Horsfield, economist at investment bank Investec. “Ultimately, we are still in a situation where a lot of what the economy is seeing is sheltered by the government stepping in. The bigger question is what will happen once we are through all of this.” The BoE is unlikely to worry about temporary mismatches of demand and supply as the economy reopens. As Bailey signalled last week, the risk is of a more persistent hit to supply, if structural changes such as the shift to remote working and online retail leave people with the wrong skills for the jobs available, or if companies’ capital is tied up in the wrong locations.

No one knows how this will play out: there is a wide range of estimates for the degree of permanent damage to the UK’s potential output — the amount the economy can produce without fuelling inflation. Nor will it be easy to measure inflation. From airfares to cinema tickets, the ONS has been unable to collect prices over the past year as it usually would, and consumer spending patterns have been far from typical. What is clear is that the headline rate of inflation is increasingly unlikely to reflect individuals’ experience. This is not only because essentials such as food and energy make up a bigger share of spending for poorer households, while those on higher incomes spend more on services. Davies noted that the spread of prices the ONS collects for many items it tracks had widened. Thirty years ago, most pubs charged around 80p for a pint of bitter: now, a £2 pint is typical but the range goes to £6. This holds for many other items. “The problem of using one number is getting bigger over time,” he said. “People in Britain face very different rates of inflation and essentially live different economic lives.”