Weighing up inflation
Rising energy and food prices have brought both positive and negative consequences. We ask two local economists to assess the pros and cons of both for the Northern Ireland economy
By Richard Ramsey, Chief economist at Ulster Bank
With explosions at nuclear reactors, air strikes on Libya and Bon Jovi selling out at concert venues around the world, you could be forgiven for thinking we are back in 1986. This is particularly the case with the soap opera Dallas, which had its most memorable episodes that year, about to make a comeback on our screens.
From an economic standpoint, there are also strong parallels with the 1980s. Northern Ireland has experienced its first recession since that decade. Chancellor George Osborne recently re-launched the old enterprise zone policy of that era. At a global level, the main threat to economic growth, as in the 1970s and 1980s, is the price of oil.
Since 1973, the UK has experienced five oil shocks — each followed by a global recession. There is a fear that history will repeat itself. Ongoing geopolitical tensions within North Africa and the Middle East have already pushed the oil price to almost $120 per barrel — some $27 below July 2008’s record high. From a UK perspective, however, the price of oil is actually closer to its record high than many people think. Back in 2008, the sterling/dollar exchange rate was £1 = $2. Now, with sterling around $1.62, the oil price has pushed through the lesser known £70 per barrel to within £2 of the 2008 high of £73.65.
Back in 2008, the oil price peak was demand-driven, stemming from rapid economic growth in Asia and emerging markets. This time, supply and demand are moving in opposite directions and there are fears this trend may continue. Even before the recent outbreak of social unrest in North Africa and the Middle East, the oil price was at $100pb. Once again, rapid growth in Asia and emerging markets is increasing demand. Meanwhile, the fear is that unrest might spread to Saudi Arabia — the world’s second biggest oil producer — restricting supply further.
Last month the International Energy Agency’s chief economist argued that “the age of cheap oil is over”. Moreover, the importance of stability in the Middle East and North Africa is underscored by his claim that 90% of growth in global production over the next decade is going to come from these regions.
Higher oil prices pose a significant threat to Northern Ireland’s economic recovery. Not only has the oil price rise helped push petrol prices some 20% higher in just 13 months, it has contributed to food and wider commodity price inflation. For example, the manufacture of metals and plastics are energy-intensive and the demand from Asia and emerging markets, alongside oil price rises, have pushed commodity prices to record highs. As a result, energy and commodity input price inflation is squeezing profit margins. This is prevalent within the tourism sector, which is experiencing both rising food and energy costs at a time of subdued demand.
This is also putting additional pressure on shrinking budgets in the public sector. Public transport prices will inevitably rise while the free transport for citizens over 60 years becomes more costly. Fuel running costs for vehicle fleets within local councils and the police will also eat up an increasing share of budgets. Everything from air conditioning to heating swimming pools will become more expensive at a time of declining budgets.
Northern Ireland is vulnerable to inflationary pressures as it has the lowest average annual wage of all the UK regions. Furthermore, NI already has the highest petrol prices within the UK and the highest levels of fuel poverty.
From a consumers’ perspective, the timing of the price rises in things such as petrol and home heating oil is concerning. They are occurring when unemployment is rising and household incomes are being squeezed by pay cuts or pay freezes.
Fortunately, rising oil prices also have some benefits. ‘Eco-warriors’ who have installed solar panels, or other forms of green energy, will see a reduction in the payback period for their investment. Demand for green technology will also increase. According to the RAC, the surge in petrol prices has led to changed behaviours and an increase in ‘eco-driving’, with fewer car journeys and people driving to conserve fuel. The net result is less pollution, fewer accidents and reduced congestion. With real incomes being squeezed, individuals will be more receptive to alternative forms of affordable public transport and more flexible forms of working, including at home, to minimise travel costs.
Higher oil prices are also a mixed blessing for firms in the local food industry. Higher oil prices mean higher transport costs for food exports, which presents some challenges. But this has also resulted in South American meat exporters becoming priced out of markets that our local firms serve.
In the words of Queen and Bowie’s 1980s hit, the local economy may be ‘Under Pressure’, but, hopefully, the recovery, just like Bobby Ewing in Dallas’s most famous episode back in May 1986, won’t be killed off.
By Philip McDonagh, Economist
We all eat food. So we ought to be interested in what happened to the price of food over the past year and what is going to happen in 2011. The average price of food and soft drinks in the UK rose by 6.2% in the year to February 2011. This is higher than the rate of increase in most of our European neighbours.
Anyone doing the weekly household shopping, or in my case, watching the monthly credit-card payments appearing on my bank account, will not be surprised by this figure. Coming on top of rising fuel prices, this is putting huge pressure on many Northern Ireland households at a time when incomes are getting squeezed.
But are there not winners as well as losers from rising food prices? Maybe consumers are suffering, but surely our farmers and food manufacturers are benefitting from increased incomes from rising prices for their products.
Unfortunately the reality is not so simple and some of the same factors that are pushing up food prices are also pushing up the costs of food production, leaving profit margins unchanged or even reduced. The only winners from inflation tend to be the speculators.
Why have food prices begun to soar again after being relatively flat during 2009 and 2010?
Unusual weather conditions in various parts of the world, leading to temporary shortages of some products, have undoubtedly played a part. However, rising global demand for food is the main factor as a result of growing and more affluent populations in the emerging economies of China, India, Brazil and elsewhere. The IMF has warned that this structural shift in demand will result in a prolonged period of high food prices.
On top of this, as we are all too aware, oil prices are rising rapidly. As oil prices rise, the use of grain for bio-fuels becomes more viable and pushes up the price of grain and cereals. A new bio-fuel plant owned by BP and Dupont is about to open in Hull and will buy 1.1m tonnes of British wheat to produce 420m litres of bioethanol which will be blended into petrol to replace oil. This will produce cheaper fuel but will indirectly increase the price of food. Just to make things even worse for the poor old shopper, the weakness of sterling has meant that food prices have risen faster than elsewhere. Not only are we good exporters, we are also good importers and when sterling is weak this pushes up import prices.
So as a result of all this we have seen rises over the past year of nearly 6% in the price of bread and cereals, over 8% in meat prices, 10% in the price of fruits and 11.5% in the price of fish. On the other hand, the average price of vegetables has risen by only 3% and of milk, cheese and eggs by 2%.
However, while consumer prices have soared, so too have the costs of inputs for both farmers and food processors. Exactly the same factors that are pushing up the price of food are pushing up the input costs of producers — animal feed prices and fertiliser costs are directly impacted by the rise in oil prices and these markets have seen sharp increases in recent months. The price of oil also pushes up the price of transport which impacts on production costs and margins.
Then there is the question of which part of the food chain actually benefits from rising prices. Farmers have long maintained that the power of the supermarkets has allowed them to keep up their profit margins, while driving down the prices paid to producers. Government has tried to investigate these claims but has not come up with a solution that satisfies everyone. Meanwhile, prices keep on rising and producers argue that their margins are being squeezed.
So it looks like we are faced with further rises in food prices at least in the short term as the underlying factors play out in the various markets. A lot hangs on the future course of oil prices which underlie much of the food price rise but there is little prospect of our weekly shopping bill shrinking in the near future.
Perhaps the silver lining is the opportunity for our food manufacturing sector to sell into the huge British market. The UK has a food trade deficit of over £18bn per year and with pressure from the UK Government to increase the level of food security by producing more of our own food, this represents a real business market opportunity for Northern Ireland’s food processors. The Scottish and Republic’s food processing industries, our closest competitors, have shown the way and are already targeting this market.