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Our views 18 October 2021

JP’s Journal: Carrots, milk and the Bank of England

5 min read

The recent spike in gas prices has focused attention on how we are to transition to a low carbon economy and who will bear the costs. The money involved is huge and consumers will want sheltering from the impact: so, government, or more correctly, taxpayers will pick up some of the bill.But we also need to look at how we tax.

The demise of petrol and diesel cars will mean that the tax take from fuel duty will stop and this will leave a massive hole in budgets. I guess the electric cars we drive in the future will be subject to road tolls or capture the mileage undertaken – with a resulting tax charge.

Another area that caught my attention is food prices. There has been much discussion on food poverty in recent years, with Marcus Rashford leading the campaign for more free school meals and he has certainly outpaced the Prime Minister on that score. Will prices go higher as a result of Covid and Brexit? The bosses of some leading companies think so – Heinz warned last week as did the UK’s leading poultry supplier.

When you look at the figures the thing that stands out is how UK food prices, over an extended period, have not risen but actually fallen quite dramatically in real terms. Let’s look at three staples: in 1988 one kilo of chicken cost £1.83 whilst today a whole chicken weighting 1.7kg can be bought for £3.75. A pint of milk was 26p and today four pints can be bought for £1.15. Carrots were 50p a kilo in 1988 and I can buy them at 60p now. Over this period general prices have risen nearly three-fold; in real terms these items have seen massive relative price deflation. These may be extreme examples but it is generally applicable to foods – with only white fish outpacing inflation. To repeat a comment from the boss of that UK poultry supplier: How can it be right that a whole chicken costs less than a pint of beer? Or, for that matter, how does milk cost less than bottled water?

Well, prices are set by supply and demand – and just like energy, the UK has become reliant on cheap imports. The amount of food produced domestically has shrunk as cheaper alternatives from the EU and elsewhere, coupled with changing food tastes (not many bananas grown in the UK), have reduced domestic production to less than two-thirds of actual consumption. This is not the whole story. The buying power of supermarkets, the availability of cheap labour and higher productivity through mechanisation have all contributed to this dramatic price adjustment. Like energy, I think current circumstances will lead to a debate on how reliant we are on imports. And, again like energy, this will lead to higher prices as we seek greater security. As the UK consumer commits less than 10% of total spending to food at home, the second lowest in the world, the impact is manageable for most. Governments will need to protect the vulnerable, but the era of ultra-low food prices may be ending.

Cash and government bonds

With Andrew Baily, Governor of the Bank of England (BoE), warning that the BoE would “have to act on inflation”, the question becomes when will the central bank tighten policy – not if. My colleague Melanie Baker thinks Q1 next year is most likely – but does not rule out a November 2021 hike. An early rise in rates will come as a shock to consumers – as the UK public haven’t been prepared for higher mortgage rates. At the present time, according to the BoE’s own household inflation attitudes survey, less than half of respondents expect a rate rise in the next year.

The best explanation for the shift in Bank of England stance is that they are more worried about medium-term inflation risks. However, as Melanie says, a lot of the factors pushing up prices currently look transitory: energy prices, global supply chain disruption and Covid related labour shortage problems.

Yields on 10-year UK government bonds fell mid-week although sentiment remained troubled by inflation concerns. UK breakeven inflation rose to over 4% at the 10-year point and is approaching 3.7% at 30 years. Although a bit distorted by the change in inflation linkage (Retail Price Index to Consumer Price Index in 2030) markets are pricing inflation well above the BoE’s target. It was a similar pattern in the US: nominal yields a bit lower but implied inflation firming. Euro area concerns about inflation were also reflected in higher yields although German 10-year rates remained negative at -0.15%

Rates for 12-month cash rose over the week. In the UK we hit 0.55%, nearly 20bps higher than at the start of the month. US rates also firmed, but by less.


Risk assets have not sold off as much as some expected given the rise in bond yields. I think this reflects a view that we are still in a low rates world, and that credit and equities look better value than government bonds in such an environment. Investment grade credit felt weak on certain days last week – but overall credit spreads did not really move. The picture in high yield was slightly different, with spreads a bit wider. However, this reflected weakness in emerging market credit rather than concerns about developed market high yield.

The next few months will be bumpy: for investors, governments, and central banks. There may be pockets of inflation that become more entrenched, such as food, but elsewhere there will be solutions. Let’s hope the BoE does not compensate for being late to tighten policy after the financial crisis by being too pre-emptive this time – after all, their tools will not address supply disruption and higher energy prices.

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