After years of deflation when it comes to food prices, research from Verdict Consulting has shown that 2008 saw a sharp increase in food prices.

According to the research, for the period of 12 months up to the end of December 2008, food price inflation hit 11.9%. It also showed that the monthly increase from November reached 1.4%.

The Verdict has said that: “the good news for consumers is that the pace of food inflation is easing.”

This news came on the cusp of research that was expected to show that inflation eased considerably in December.

A Reuters poll has tipped that the annual inflation rate will have fallen to 2.7% in December, from 4.1% in November.

Consulting director for the Verdict, Neil Saunders has said: “consumers have felt the pinch of rising food prices and have reacted by shopping around more, using discount supermarkets and buying less.”

The Verdict has also said that people are becoming more sensitive and “increasingly willing to sacrifice convenience for low prices.”

This is shown by the fact that, on average, in 2007, people shopped at 1.9 other stores on top of their main store, while in 2008, this rose to 2.4 additional stores on top of their normal retailer.

Also, it has been recorded that laundry, washing and paper product sales were up 21.6%, while meat and fish sales increased 17.7%, and fresh fruit and vegetable sales rose by 16.8%.

The major concern for the first half of 2008 was the continuing rapid inflation, but it seems that worry has now been reversed to worries about deflation as the economy slows down and consumers cut how much they spend.

The Consumer Price Index (CPI) is tipped to stay above the UK’s target on 2% inflation, but is expected to be far from last September’s high of 5.2%.

At the same time, the Retail Price Index (RPI) is expected to fall to an annual rate of just 0.8% in December, from 3% in November. This figure includes mortgage payments.

In an attempt to boost the economy, the Bank of England reduced its interest rates to 1.5% earlier this month, its lowest level in the Bank’s long 315 year history. Despite this, many economists are predicting that the economic slowdown will continue for some time yet. As credit remains difficult to access and manufacturing slows and the number of unemployed increases.

After a 16 year high, UK inflation fell in October, as oil and transport costs, as well as fuel prices, fell.

The Consumer Price Index (CPI), which was at 5.2% in September, has fallen to 4.5% in a month. According to the Office for National Statistics (ONS), this is the biggest month-on-month drop in 16 years.

The Retail Prices Index (RPI) also fell from 5% to 4.2%, its biggest fall since 2003. This index includes house prices, and is often used for agreeing pay settlements, or calculating the up rating of benefits like pensions.

Core inflation, which includes the likes of food, tobacco and alcohol, fell from 2.2% in September, to 1.9% last month.

The ONS has said: “The largest downward pressure on the CPI annual rate came from transport costs where the price of fuels and lubricants fell this year but rose last year… The decrease this year was triggered by a sharp fall in the price of crude oil.”

Other things that may have contributed to the decrease are the fall in prices of both air and sea transport, and from food and non-alcoholic drinks, as the prices of meat were cut in the supermarkets.

The UK economy shrank for the first time since 1992 this year, falling by 0.5% in the third quarter of 2008.

The Bank of England has said inflation could fall below its target of 2% next year, and could even drop as low as 1%.

All of this led to the Bank of England lowering its key Bank Rate in October to just 3% – its lowest level since 1955.

Chief economist at the British Chambers of Commerce, David Kern, said: “Following these [inflation] figures, it is clear that UK interest rates will be cut further, most likely to 2% in early 2009.
“One cannot rule out rate cuts below 2% later next year.”

The slowing UK economy is also pulling down cost-of-living prices, due to falling food and fuel prices. The fact that crude oil is remaining at under $60 a barrel is primarily responsible for decreased fuel prices.

Senior economic advisor to Earnest & Young ITEM Club, Hetal Mehta, has said: “With commodity prices falling and the economy shrinking fast, inflation is going to undershoot the 2% target by the middle of next year.
And while it is still unlikely on the CPI measure, the prospect of deflation cannot be ruled out.”

Figures from the ONS also show that output prices (the prices of food leaving the factory) dropped by 1% in October.

Input prices, on the other hand, (the cost of the raw materials bought by the manufacturer) dropped by 5.6% in October, the biggest drop in 12 years.

The Governor of the Bank of England, has admitted that it’s very likely that the RPI will reach negative percentages next year.

The Bank is also expected to drop its interest rates to 2% in December, its lowest level since the 1930s.

Although a short period of deflation would not be too bad, a prolonged period could be disastrous, as consumers hold off buying goods thinking they will be cheaper later. This can lead to firms selling less and wages being cut, and overall, less money to spend meaning demand falls even further.

Almost 200,000 council workers in Scotland are staging a 24-hour walkout over a pay dispute, causing disruptions to local services such as schools, rubbish collection and ferry crossings. The council workers – members of the GMB, Unite and Unison unions – are due to take part in the strike after they rejected a 2.5 percent deal over the next three years.

Local government group Cosla, said that councils could not afford to increase the pay offer. Scottish ministers have urged both sides to resolve the dispute.

Industrial action will take place across the country; however the level of disruption differs in council areas. Many schools, libraries and day care centres will be closed, along with disruptions to school buses, school dinners and meals on wheels vans.

Caledonian MacBrayne, the ferry operator, said it would cancel sailings from Rothesay and Dunoon piers, due to action by Argyll and Bute council workers.

David Prentis, general secretary of Unison, which represents around 100,000 workers, said he hopes the public would understand the concerns.

He said: “Our members are taking this action very reluctantly. They care deeply about the vital services they provide and those who depend on them and we apologise for any disruption.

“However, members feel they have no choice when the employers’ offer is effectively a pay cut.”

Council headquarters will be picketed, and Union members will also distribute leaflets to commuters at Edinburgh’s Waverley Station, along with a rally that is due to start at 12.15 BST today (20/08/08) in Glasgow’s George Square.

Michael Cook, Cosla spokesman for the Scottish Employers, said councils were disappointed by the strike action, and had attempted to minimise disruption.

He said: “The issues are difficult and complex and need to be carefully thought through.

“However, as soon as possible, we will arrange talks with the trade unions in a bid to reach a settlement which takes account of the soaring cost of living which affects councils just as much as our workers.”

Finance Secretary John Swinney, said: “I would encourage both parties to try to resolve the dispute to ensure that there is no further interruption to public services and I hope that resolution can be achieved by local authorities and their employees.”

Mr Swinney’s comments came after unions last week called on the Scottish government to intervene and provide “adequate funding” to local authority employers to address low pay.

A second strike by government civil servants with the Public and Commercial Services (PCS) union was also due to take place on the same day, following a similar strike last month.

The dispute revolves around a 2 percent pay increase, which its members say amounts to a pay cut while inflation rises above 5 percent.

Inflation reached 4.4 percent in July – the highest since the early 1990s and more than double the government’s target – as economists predict a further rise to 5 percent in the autumn. Rises in food prices, fuel costs and disappointing price cuts in the summer sales, have caused this latest jump, which marks the fourth monthly increase in the consumer price index.

In the Bank of England’s last quarterly forecast in May, it gave less than 10 percent probability that inflation would be as high as it is now. The bank will set out its latest forecasts for the economy and inflation on Wednesday.

Several economists expect that the Bank might even be forced to raise rates to bolster its diminishing reputation for keeping to close to target. Very few economists expect rate cuts this year.

The Bank’s forecasts on Wednesday will show that, apart from two brief interludes, it expects inflation to be too high for the five-year stretch between the summers of 2005 and 2010. High inflation in July was also feed further rises next January when regulated train fairs raise by at least 6 percent, 1 percent more than the 5 percent rise in the retail prices index last month.

Economists say the figures were shocking because they were worse than those in other countries, and were not limited to food and petrol price rises and did not yet include announced rises in gas and electricity prices. Relief will come, however, from falling oil and grain prices in the coming months, but this will take quite some time to work into lower consumer price inflation.

Vincent Cable, the Liberal Democrat Treasury spokesman, said: “It’s very clear that we’re in for a dose of stagflation, with the economy slowing abruptly and inflation too high and increasing.”

Thanks to rising inflation, many private sector companies are being forced to settle pay deals at levels that threaten the government’s inflation targets, because of clauses in long-term pay deals.

Only last week Shell tanker drivers agreed to a 14 percent two-year settlement with managers, which has prompted fears this would set a precedent for other workers and calls for restraint from ministers.

Research group IDS Pay Databank’s analysis shows many other companies which previously negotiated two or three-year pay deals – at a time when inflation was expected to stay low for years – are having to give their workers a wage “kicker”.

This is because a large portion of such deals are linked to the Retail Price Index, which has risen sharply in recent months to 4.3 percent.

Such agreements are set to undermine the Alistair Darling’s pleading. Speaking to the BBC on Sunday, the chancellor said that “Pay awards in both the public and private sectors have got to be consistent with our inflation target of 2 per cent.”

Mr Darling and John Hutton, the business secretary, argued last week that the tanker driver’s settlement was a one off. However, other recent deals include Drax Power, who agreed a 7 percent pay rise for 60 workers, forming the second of a two-year deal. Babcock Engineering recently agreed a 7.6 percent increase with 50 workers.

Barclays Bank has implemented a 5 percent pay increase for 55,000 workers, as the first stage of a three-year RPI-linked deal.

These deals are much higher than the 3.3 percent Consumer Price Index measure of inflation. The government has tried to keep public sector deals at about 2 percent.

David Frost, president of the British Chambers of Commerce, described the trend as a self-fulfilling scenario which would fuel inflation further.

IDS has indicated the highest pay awards in three months to April – the last month for which accurate figures exist – were made to companies in energy and water, chemicals and engineering. One in five deals over 4 percent were lined to RPI.

Lois Wiggins, a researcher at IDS said: “The main reason they are now settling so high is because many are part of long-term deals, which means that in the second or third stage of these deals RPI is being used to work out the settlement.”

The most recent report by the research group, which showed wage inflation of 3.8 percent, suggested employers had been “wrong-footed” by predictions inflation would remain subdued.

This will add further pressure on the government as it seeks to keep a hold on wage inflation. Several unions have openly defied this policy in recent days, with Unison threatening to re-open a key NHS agreement for 500,000 employees.

Alistair Darling and Mervyn King yesterday delivered a bleak assessment of economic prospects for 15 years in what the Bank of England governor said was “the most challenging period” since 1997.

Mr King, during his annual Mansion House speech to City grandees, warned households should prepare for the “average take-home pay [to] stagnate this year”, and said that “the squeeze on real income growth is likely to mean that both house prices and consumer spending weaken together”.

In addition to this, the chancellor conceded his Budget forecasts would not be met, accepting that inflation would be higher than predicted and that no country could escape the effects of higher inflation on real incomes and economic growth.

Both Mr Darling and Mr King stressed the need for wage restraint. The chancellor insisted “inflationary pay settlements would undermine rather than raise people’s living standards” and the Bank governor waned that an economic slowdown “will be necessary to dampen price and wage pressures”.

The Shell tanker driver wage dispute is just one example that some companies and employees will do what is best for them rather than for the wider economy. The government insisted that the drivers 14 percent over two years, pay deal was “particular” to the industry, but Mr King issued a warning that he would not allow higher pay deals to result in ingrained inflation.

In a sign that the Bank of England was now thinking about interest rate rises, the governor said: “There should be no doubt that the Monetary Policy Committee is prepared to take whatever action is needed to return inflation to the 2 per cent target and to keep expectations of inflation in the medium term anchored to the target.”

A much tougher statement of intent than he gave in his letter to the chancellor on Tuesday, the minutes of the MPC meeting, published on Wednesday, revealed that the committee had discussed an immediate rise.

The governor made it clear he was not going to go soft on inflation, quite the opposite from his letter earlier this week. He fought back at critics who have called for the inflation target to be changed to ignore current pressures from abroad. “Target growth, not inflation is the cry,” he said. “I could not disagree more.”

“Without a clear guide to the objective of monetary policy, and a credible commitment to meeting it, any rise in inflation might become a self-fulfilling and generalised increase in prices and wages,” Mr King added.

His main message was that if everyone tightened their belts, accepted “a loss of real purchasing power” and understood the Bank could not side-step tough choices in the coming year, things would look up thereafter.

Underlying sales at supermarket group J Sainsbury rose by 3.4 percent in the first quarter of the financial year, putting the retailer behind Tesco’s 3.5 percent increase and Wm Morrison’s 7 percent rise over similar periods.

Sainsbury’s chief executive, Justin King, said today that food price inflation in his branches “was a little over 3 percent in the quarter, up just 2 percent in the previous quarter, but well below official government statistics.” He said he agreed with Bank of England governor Mervyn King that inflationary pressures would continue for the next six to 12 months, adding that “prices for Sainsbury’s non-food items were still showing some deflation.”

Darren Shapland, finance director, said that most of the 3.4 percent like-for-like sales increase came from food price inflation, with “volumes just above flat”. The company’s fuel sales benefited from higher prices and from extra volumes as motorists shopped around for cheaper petrol.

Mr King said he was pleased with the company’s performance in the quarter, which met the group’s expectations. Although the group adjusted the number to take account of the changed timing of the Easter weekend, the quarter compared with a strong period last year, when like-for-like sales were up 5.1 percent.

Mr King said Sainsbury was “fighting hard for customers” whose household budgets are being squeezed by increasing its emphasis on promotional offers, extending its “Basics” range of cheaper foods and launching a “Feed your Family for a Fiver” campaign.

Recent consumer research suggests customers were cutting back on eating out in restaurants which could benefit sales of Sainsbury’s, up-market, Taste the Difference range.

Mr King was happy to report that non-food sales were continuing to “grow strongly” as ranges were expanded. Online sales improved by more than 40 percent, and improvements to the supply chain in recent years meant product availability in shops had risen further.

The company’s total sales in the 12 weeks to June 14th rose by 8.1 percent, given a boost by the increase in fuel prices.

Excluding new store openings like-for-like sales rose 7.3 percent, including fuel sales.

Echoing last weeks trading update from Tesco, which said its growth had slowed from more than 4 percent in the early weeks of its fourth quarter, the 3.4 percent increase in sales marks a slowdown from the 4.1 percent growth Sainsbury reported in the fourth quarter of last year.

Sainsbury shares have dropped since its 600p a share bid from a Qatari-backed investment group was dropped last November – Qatar holds a 24.9 percent stake in the company. Shares were 5p lower in early trading at 331p.

Since gaining independence, the Bank of England’s investors have been more sceptical of the way the bank tackles inflation.

The widening gap between the yields on index-linked government bonds and conventional gilts indicates bon-market investors are willing to pay much higher prices for inflation protection. As Britain enters its most inflationary period for more than a decade this suggests doubts about the credibility of the monetary framework.

Ex-chief economic adviser to the chancellor, and current children’s secretary, Ed Balls described inflation expectations in bond markets as the “most important” test of credibility and confidence in monetary policy.

Paul Dales of Capital Economics said the gap could be the “first sign that the markets are starting to lose faith in the ability of the UK’s policymakers to deliver a low and stable inflation environment”.

Alongside rising surveys of household inflation expectations and corporate pricing intentions, economists said there was a greater risk of higher inflation returning to normal British life.

“In every measure you look at, inflation expectations have already moved out of the range they have occupied in the last eight or nine years.” Malcolm Barr of JPMorgan said.

Sensing that a loss of confidence in the UK from abroad is under way after sterling’s continued decline, Danny Gabay of Fathom Consulting said: “The … markets believe the ‘macro policy miracle’ [since 1997] is more style than substance”.

Over a 20-year period, the government bond market now expects retail price inflation to average 3.76 percent, according to Bank of England figures, compared with 3.47 percent on the last trading day before Gordon Brown announced Bank independence. By comparison, the 20-year expectations two years ago were just 2.85 per cent.

The warning issued by Mervyn King, the Bank’s governor, that the “nice” decade (of non-inflationary constant expansion) was over has prompted other economists to offer their own acronyms. Few yet expect a recession, but Michael Saunders of Citigroup said times will be “vile” – “volatile inflation, less expansionary”.

Urging policy makers to fight higher inflation, Jean-Claude Trichet, president of the European Central Bank said, soaring oil and food prices had created “demanding times, challenging times”, and that the challenge was to ensure the pressures did not create lasting “second-round effects” by feeding through into wage deals.

Mistakes made at the time of the first “oil shock” in the 1970s had “enshrined the high level of inflation for a long period” and led to mass unemployment. Mr Trichet sounded the alarm on inflation even as he acknowledged that financial markets were still witnessing an “ongoing, very significant market correction”.

While we hear news that inflation in the manufacturing sector has moved to its highest level since 1995, many people are starting to ask what inflation actually means to them. So what are the positive points and negative points of inflation?

Inflation is the change in the cost of an item or items over a given time span, normally 12 months, showing how the price of the said item has changed over the period. While it is safe to say that prolonged high inflation will ruin an economy, it is also safe to say that negative inflation or zero inflation also has the potential to cause major problems. Here we list some of the positive and negative aspects of inflation :-

Positive Aspects

Controlled inflation in any economy allows manufacturers and services providers to move the cost of the goods / service higher without pricing themselves out of the market. Inflation is a direct result of the supply and demand levels for a particular product. i.e. if there is little demand then the potential to move prices higher is smaller, yet if there is high demand and few providers, then those in the market can afford to increase their prices.

Increased prices mean increased income and so long as costs are kept under control it also allows the companies involved to increase the salaries of their workers. As incomes rises, more people will spend and the economy will continue to grow.

Inflation is also very important to the property market because inflation will allow rental charges to grow, and because the value of property is normally directly related to the rental income, this will keep the property market moving forward. Again, it is a controlled rate of inflation which is essential because when rental inflation moves out of synch with the market this can cause major problems.

Negative Aspects

While a controlled rate of inflation is good for the economy, a run away rate can have serious implications with costs racing ahead to levels which are unsustainable. The problem seems to occur when people have excess money in their pockets to spend and demand for products is pushed higher and higher. As the cost of the products moves higher there is a natural increase in costs with each element of the production chain wanting a share of the rise – including the workers.

When demand starts to fall many companies are left high and dry with costs which are unsustainable against the falling price of goods and competition. As more companies struggle we see more and more price reductions with many companies forced to sell goods at knock down prices. This can then move the economy into a vicious circle, where cost cutting means more jobs are lost, meaning less money for people to spend which then transfers into reduced sales then to more costs cutting, etc, etc.

Summary

While governments around the world will use different techniques to control inflation, one of the main tools in the UK has been interest rates where the authorities look to make borrowing more expensive to curb overspending, hence reducing demand and prices to acceptable levels. Where demand is falling the authorities would look to reduce interest rates to make borrowing cheaper, giving the consumer the opportunity to borrow and spend – increasing demand. At the moment we are in a very difficult situation in the UK because the cost of oil has increased, which has been passed down the line into business and onto consumers. So prices are rising while the economy is under pressure – a very very tricky situation.

As the oil prices continues to hover around all time high levels we are starting to see genuine concern that the Bank of England may not be able to force through major reductions in interest rates, as many had expected. But how can inflation affect the direction of interest rates?

Historically the weapon of interest rates has been used to either increase economic activity, by reducing rates and making debt cheaper, or increasing rates and making debt more expensive. The cheaper it is to borrow money the more chance of the consumer being in a position to finance their debts and have more money in their pockets, as well as offering more access to funds for businesses looking to invest into their operations.

At this stage of the economic cycle we are seeing consumer demand come under pressure due to the ongoing economic conditions, but we are also seeing businesses increase the price of goods and services directly linked to the price of oil. The increased cost of transporting goods needs to be passed onto the customer at some stage, whether partially or fully, and this is what we are starting to see now. However, there is concern that should interest rates fall to far and the price of oil stays around current levels, we will actually see businesses increase their prices yet further – due in the main to the consumers access to cheaper debt and resulting growth in demand for services / products.

As we see inflation move towards the upper band of the UK government’s target, with many suggesting that it will break through the upper limit very soon, there is potential for a further substantial rise in the rate of inflation as interest continue to move lower. The Bank of England have a very difficult balancing act to figure out, on one hand they need to make cheaper funding accessible to business and the consumer to promote demand, but they also need to ensure that price inflation does not get out of control.

A very very difficult situation to handle!