Inflation and Exchange Rates

Generali

!!!!!!? wrote: »

The excuse is that most of the inflation is 'external'. This is of course irrelevant as higher interest rates would boost the value of Sterling which would reduce prices (in pounds) of all those external factors.

I'm not picking on your post in particular !!!!!!, more using it to make a general point.

I've seen a few people on here talk about exchange rates and inflation and the effect that the former has on the latter particularly at the moment.

To take the petrol price, seen (correctly IMO) as a driver of inflation:

Fuel duty is, I believe, 50.35p/litre. If we assume petrol at 120p/litre, then about a further 18p is payable in VAT (VAT is payable on the duty on fuel!!!). That means in total we pay 51.65p for the fuel and the rest in tax.

To pick an utterly arbitary figure, if we were to get petrol back down to 90p/litre we'd have to pay only 26p/litre for the fuel (13.5p in VAT plus the 50.35p duty). That means the pound would have to double in value against the dollar to halve the sterling price.

That's pretty sweet if you're off to Florida for your hols. Less so if you're relying on your job working for an exporter to pay for the holiday.

Other goods with less duty need lower rises in sterling to have the same sort of impact but realistically speaking, anything more than a rise in the pound of 10% or so is going to have a serious impact on exporters and those that compete with foreign companies for customers.

To put the fall in the value of the quid into perspective, the trade weighted index has fallen from about 99 to about 93 since my 35th birthday a couple of years back. In that time the highest it has been is 106 and I would guess it has averaged about 100 or so. This isn't a calamatous collapse. (link).

To put inflation into context, the RPI is lower than it was at any point between April 1968 and March 1983 (link). It's higher than it should be but hyperinflation it ain't. As an aside, it's funny that people that were claiming a few months ago that CPI was ridiculous are now seizing on it rising as evidence that we are about to be tipped into some Weimar Republic-style callamity.

My feeling is that the current inflation is classic 'demand pull' inflation. Ie too much money is causing prices to rise. As globalisation has proceeded though, the money supply in China and India matters more than our own for imported goods. The BoE probably has this one right - they need to raise rates if prices of domestically produced things that don't compete with imports start to rise. Unless that happens there's little they can do.

fc123

Do I read this correctly; It's not so bad....could be whole lot worse...remember 68 - 83? Or it's going to get worse......just like 68 - 83?

Generali

fc123 wrote: »

Do I read this correctly; It's not so bad....could be whole lot worse...remember 68 - 83? Or it's going to get worse......just like 68 - 83?

My points are 2:

1. Things aren't as bad as all that regarding inflation (eg it was much higher from 68-83).
2. That increasing the exchange rate to fight the current inflation isn't going to work.

tradetime

Generali wrote: »

My points are 2:

1. Things aren't as bad as all that regarding inflation (eg it was much higher from 68-83).
2. That increasing the exchange rate to fight the current inflation isn't going to work.

I'll take your word for 1. as I haven't really got the interest to research it, and your posts seem generally well balanced and thought out from what I have read in the past so I am sure you are correct.
As for 2. I am inclined to agree, the trouble with a lot of armchair economists, is that they are able to treat problems one at a time ie fix inflation raise rates. Howeve things are rarely that simple, raising rates may fix inflation, but it cools the economy at the same time.
In the current incarnation of inflation we are experiencing a global phenomenon, and simple monetary policy here will have little impact on it. As China and India become more wealthy, they are demanding more of the things we have which is putting an upward pressure on inflation worldwide, I also believe speculation is playng a larger part than many others feel. Raising interest rates here would probably have little effect on inflation because I believe the damage it would do to our economy would negate any positive effect on the pound. We already have the one of the highest interest rates of the of the G7 countries and yet the pound is relatively weak against its peers, if our economy slows anymore this will increase.

Generali

tradetime wrote: »

I'll take your word for 1. as I haven't really got the interest to research it, and your posts seem generally well balanced and thought out from what I have read in the past so I am sure you are correct.
As for 2. I am inclined to agree, the trouble with a lot of armchair economists, is that they are able to treat problems one at a time ie fix inflation raise rates. Howeve things are rarely that simple, raising rates may fix inflation, but it cools the economy at the same time.
In the current incarnation of inflation we are experiencing a global phenomenon, and simple monetary policy here will have little impact on it. As China and India become more wealthy, they are demanding more of the things we have which is putting an upward pressure on inflation worldwide, I also believe speculation is playng a larger part than many others feel. Raising interest rates here would probably have little effect on inflation because I believe the damage it would do to our economy would negate any positive effect on the pound. We already have the one of the highest interest rates of the of the G7 countries and yet the pound is relatively weak against its peers, if our economy slows anymore this will increase.

The BoE's point as I understand it is that a slowing world economy will reduce worldwide inflation and I'm inclined to agree.

If anything I suspect that deflation is a bigger risk given the drastically reduced rate of money supply increase that will result from the credit crunch.

Time, as ever, will tell.

tradetime

Generali wrote: »

The BoE's point as I understand it is that a slowing world economy will reduce worldwide inflation and I'm inclined to agree.

If anything I suspect that deflation is a bigger risk given the drastically reduced rate of money supply increase that will result from the credit crunch.

Time, as ever, will tell.

Yes, deflation is not something that is talked about a lot, I may have to spend some time reading up on the undesirable effects of deflation, as it is indeed a possible scenario.

fc123

Generali wrote: »

The BoE's point as I understand it is that a slowing world economy will reduce worldwide inflation and I'm inclined to agree.

If anything I suspect that deflation is a bigger risk given the drastically reduced rate of money supply increase that will result from the credit crunch.

Time, as ever, will tell.

By slowing do you mean consuming less services and stuff?
And this reduced overall spending brings inflation down or keeps it low?
Deflation could occurr as prices then fall further to encourage spending?

Just want to check I have got this right.

fc123

tradetime wrote: »

Yes, deflation is not something that is talked about a lot, I may have to spend some time reading up on the undesirable effects of deflation, as it is indeed a possible scenario.

It's rubbish...have had it in my sector for 15 years. Only snag is that we had increased volumes.
Now, volumes down...stuck with low prices.

tradetime

fc123 wrote: »

By slowing do you mean consuming less services and stuff?
And this reduced overall spending brings inflation down or keeps it low?
Deflation could occurr as prices then fall further to encourage spending?

Just want to check I have got this right.

Deflation sumarised.
http://en.wikipedia.org/wiki/Deflation_(economics)

Alan_M_2

I read these posts with interest and being in business I feel I should understand much more of it. Sadly most of it goes way over my head, mostly because I'm unaware of many of the phrases and indices that are referred to.

Would you be so kind as to explain in laymans terms why the Euro is currently so strong yet the Dollar weak against sterling and what the underlying reasons for these are (if in fact it's possible to explain in laymans terms!) I import in both currencies, In US$ from India and Euros from most of the EU......the Euro along with the restriction on mortgages is hurting me, the Dollar is helping right now. I'll be in a position to buy a reasonable amount of stock in August (in us$) , what I'm trying to decide is do I fill my boots in August in case the pound gives back some ground vs the US$, or do I stagger the orders. Ok it's difficult I know but if I understood what's moved the rates so far it might help me make a more informed decision. As these are 6 figure transactions, the rate does have quite a bearing in monetary terms.

Any information that can help me make decisions on the future of my own business are helpful, but quite often I get lost in the explanation.

Take above example on fuel duty, I've read that three times and can't get my head around the following statement "That means the pound would have to double in value against the dollar to halve the sterling price." Ok it may be late, and I may not be firing on all cylinders...but I'm reading it and it's not registering....:)

Generali

By slowing down I mean GDP falling or rising more slowly (GDP being the total of all the stuff made or consumed in the economy).

As the demand for things drops, prices fall as sellers have to compete among fewer buyers and so have to cut prices or accept lower sales.

The problem with deflation is that people stop consuming as why would they buy something today that's going to be worth less tomorrow?

The other big problem is that it increases the weight of debt on people and companies over time. What was a reasonable debt to take on to invest becomes a drag on performance or may even bankrupt companies.

From a business point of view the experience of Japan seems to show that people will spend on disposable stuff. They won't hold off buying things that they're just not going to be interested in tomorrow. They will hold off buying houses, consumer goods etc.