When costs are too much to bear

The news on UK inflation this week wasn’t good - it is difficult to find anything positive in seeing CPI inflation surge to an eleven year high of 3.8% and the RPI climbing to just under 5%. Little wonder that the government is getting more paranoid by the hour about the dangers of losing the battle on pay restraint as a wage price spiral takes hold.

The monthly inflation data tells us what has been happening to prices for a basket of goods and services - but to my mind what is more worrying is the data on input and output prices facing manufacturing businesses. My chart above shows just how steep has been the acceleration in inflation in the costs of imported foods and raw materials - costs are rising in excess of 20% pa for both categories. There comes a point when businesses simply have to raise their prices to avoid a calamitous fall in profits - and that point seems to have been reached. Manufacturing output prices are not rising at an annual rate of more than 10% and this “factory gate” inflation will flow through from wholesale to retail level in the space of a few weeks and months. If you want an early warning of why the inflation problem will not go away in 2009 - this one of the key indicators to watch.