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The message the world’s top central bankers delivered late last month could not have been clearer. Bank of England governor Andrew Bailey, and his US and eurozone counterparts Jay Powell and Christine Lagarde, all insisted that high inflation — and high interest rates — would endure.
When it comes to the US and the eurozone, however, investors remain unconvinced that what’s proved to be the worst bout of inflation for a generation will linger for as long as rate-setters claim — despite a rise in yields this week.
They still expect the Federal Reserve to cut borrowing costs starting late this year or early next, despite Powell’s bet — voiced at the European Central Bank’s flagship Sintra event — that price pressures would remain above his crucial 2 per cent goal beyond the end of 2024.
The reversal of the rapid rate rises we’ve witnessed over the past year from the ECB may take a little longer. But market pricing is wildly out of sync with the musings of the eurozone’s rate-setters, too. Investors expect a further two quarter-point rate increases in the eurozone this year, followed by a pair of cuts over the course of 2024.
In the UK, markets are shifting their expectations in the other direction. They now think the BoE will need to turn more hawkish, raising rates from their current level of 5 per cent to a peak of 6.5 per cent in March 2024, heaping more pain on the country’s mortgage-holders.
Yet, even in Britain, where price pressures remain far more aggressive than in the US or Europe, there’s a glimmer of hope over a shift in how companies set prices.
Many central banks, including the BoE, poll thousands of businesses each month to see how they set prices. Those surveys reveal costs have not only risen fast, but in frequent adjustments. The BoE’s Decision Maker Panel poll of chief financial officers at businesses shows that before inflation took off, almost half of firms would only set their prices once a year. That figure has now fallen to about a third.
That’s intuitive. The supply chain bottlenecks that emerged during the pandemic — and were exacerbated by Russia’s invasion of Ukraine — have, along with higher energy costs, exposed companies to rapid price changes. Naturally, that has meant more frequent shifts in what they charge their customers.
The change in frequency has been dramatic. According to the BoE’s Decision Maker Panel, more than a fifth of firms changed prices once a quarter last year — up from just over one in 10 in 2019. Alarmingly, almost 15 per cent changed prices once a month — compared with about 5 per cent in 2019.
But how fast will companies cut them, now pressures are easing? There are some positive signs. A chart taken from a presentation at Sintra by Huw Pill, the BoE’s chief economist, showed those businesses that had reported shifting prices more frequently last year expected inflation to be lower in 2023. They expected to raise prices by an average of 5 per cent between now and next June. That compares with forecasts of almost 6 per cent from those companies that raise their prices annually.
“There is no room for complacency about the risk of greater inflation persistence, given recent developments in services prices and wage growth,” Pill told us. “But this survey of firms’ pricing behaviour offers some evidence in the other direction.”
Firms increasingly also have space to cut prices. After soaring last year, figures out this week showed eurozone manufacturers’ costs fell outright for the first time since 2020 in the year to May, on the back of the sharp fall in energy prices. In the UK, they rose just 0.5 per cent — down almost 24 percentage points from their summer 2022 high.
In some areas, companies are responding by cutting consumer prices. US milk is one example. Over the course of 2022, the US Department of Agriculture recorded eight changes to the cost of a gallon of whole milk bought in a Washington DC store, gyrating from a low of $4.19 at the start of the year to a high of $5.04 in August 2022. After several falls since then, this year prices have already dropped three times — from $4.99 in January to $4.19 in June.
More generally, US food inflation has slumped of late on the back of falls on international wholesale markets last year. There are nascent signs that European food prices will soon catch up.
However, falls in prices might not be as dramatic as the drop in producers’ costs. Take diesel costs in the UK, which can change daily. A report by the Competition and Markets Authority showed that, when producers’ costs rose, retailers increased prices at the forecourt fast. When producers’ costs fell, they declined for consumers too — but at a far slower clip. The spread between retailers’ costs and the price customers pay was still well above historical levels as of May 2023, despite sharp falls in wholesale prices.
The mixed picture explains why rate-setters both in the UK and elsewhere are so cautious in changing their message. After originally insisting that price pressures would prove shortlived, central bankers will not want to declare victory over inflation until the evidence is overwhelming. However, investors seeking inflation clues might want to keep a close eye on the clip at which everyday items become more affordable.
claire.jones@ft.com
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