Monday 19 July 2010

It will always be inflation – UK Inflation – May 2010 Update

I am still reading on blogs and in news articles many discussions on whether going forward we will see inflation or deflation. I might as well wade into the debate and suggest that over the long term (remember I’m a long term investor not a short term trader) I believe that we will see inflation. We could even see hyper inflation. What makes me say this? Well, my first chart showing the UK RPI for starters. It has never failed to reach a new high meaning inflation. Sure we’ve seen some deflation over the short term however I believe that policy makers and governments will just not tolerate deflation as it makes debts larger and savings worth more. Given the debts of governments and individuals this cannot be tolerated. Inflation is the easy way out. I believe that as soon as deflation next appears we’ll see yet more quantitative easing or other drastic measures to try and secure inflation. If they can’t engineer the inflation quickly through moderate means they will continue taking more risks shamelessly until the risk of currency destruction through hyper inflation is upon us. That sound pretty extreme but it is what I feel today.

For now though inflation is still with us. The Office for National Statistics has reported the June 2010 UK Consumer Price Index (CPI) as 3.2% down from 3.3% and the UK Retail Price Index (RPI) as 5.0% which is down from 5.1%% last month. So at this rate it will take another 12 months for inflation to return to the Bank of England’s target of 2%. Unfortunately though we already have an inflation increase of 1.77% baked into the CPI pie the vast majority of which will hit us in January of 2011. In addition we see just about every day talk of wage increases in various factories in China. Given the number of items that I see in the UK with a Made in China sticker this also seems inflationary. In fact about the only thing I can see deflating in the near future are house prices.

As always my first chart is tracking the CHAW Index which is the RPI including all Items. I focus on the RPI as my National Savings and Investments Index Linked Savings Certificates use the RPI to index from. I currently have 21% of my low charge portfolio held within them which are proving their worth given that the RPI has been over 4% for four months now and the trend seems to be continuing. The current level of the Index remains well above the trend line and continues to diverge upwards from trend.

The second chart is again based on the CHAW Index. This chart shows annual figures based on the previous 3, 6 and 12 month’s worth of data. As of February the 12 month figure is 5.0% (as published by the ONS), the 6 month figure is 5.6% annualised down from 6.5% and the 3 month figure is 6.2% annualised down from 8.0% annualised. So the inflation continues nicely.

As always do your own research.


  1. "wage increases in various factories in China"

    I think this is really interesting. I've always thought that at some point the 'developing' world would develop and the massively deflationary impact of China throughout the NICE decade would come to an end (doesn't look so nice with hindsight though does it?).

    The question is, what happens next? Either real inflation returns (and with it interest rates at an unbelievable 5-10% - I say unbelievable as most people think this zero stuff is here for ever more), rather than the anaemic credit fuelled inflation we've had for a long time which has just about managed to offset the deflation imported from China; or we turn to somewhere like Africa and start building mega-factories there so we can exploit a new source of cheap labour all over again.

  2. UKVI's point about moving production is on the nose. There are also a bunch of developing Asian countries busy trying to supplant China as the world's source of cheap labour. Other factors can easily cancel out wage inflation anyway like the shipping prices falling through the floor.

    Those RPI-linked savings certs are the best thing going anyway.

  3. Hi UKVI

    A great point. Many companies worldwide will always chase (some might even say exploit) the lowest cost manufacturing base. For these the lowest cost is simply the cost of production + freight + freight insurance and there is no country allegiance. In my experience the leaders of this game seem to be clothing and toy manufacturers. So I guess we can keep an eye on where these are being made to understand the dynamic.

    I agree that Africa is a likely candidate however their are also plenty of Asian countries as Anonymous points out that can still be exploited. Vietnam springs to mind for some reason.

    IMO I think that the multinationals will just leave China once it becomes uncompetitive. They won't pay the higher costs and have no reason to support China. There are hundreds of countries in Africa, Asia and even South America that could still be 'used'.

    As you know I'm also supporting the fact that we are going to see some inflation. Unfortunately though those higher interest rates needed to stifle it seem to be a long way off.

    Hi Anonymous

    Unfortunately as of this week those RPI index linked savings certificates are no longer on sale. You might like todays post.