What Tesco tells us about inflation
I noted that the fall in inflation was being accompanied by a fall in wage growth and so not providing a boost to disposable income and I also noted that it was important to understand what was driving the fall. As I wrote then:
This week’s retail sales figures showed a monthly fall of 0.4% in volume terms. As Bloomberg noted the fall in inflation has been driven by “food and transport prices as the prospect of another recession weighed on the economy”.
As the economy has weakened retailers are now engaged in a full scale ‘price war’ in an effort to hang onto sales. Rather than a reduction in inflation supporting consumption, a fall in consumption is driving inflation lower. And real wages aren’t improving as the labour market remains very weak.
Today’s results from Tesco suggest that my analysis was correct.
As FT Alphaville report, Tesco’s weak performance was driven by ‘Tesco-induced deflation’:
We delivered a very good Christmas shopping experience for our customers but in a highly promotional market, the volume response to our increased investment into lowering prices did not offset the deflation it has driven. The wider improvements in the shopping trip that are an integral part of strengthening our performance are still to
work through fully.
Inflation looks set to fall sharply in 2011, driven by three factors:
- First, the impact of January 2011’s VAT rise will drop out of the comparison.
- Second, one major factor driving inflation higher in 2011 was rising commodity prices. Whilst it is impossible to rule out a further rise in commodity prices in 2012 (how many analysts predicted the Arab Spring and its impact?) it seems unlikely. Note that EDF cut gas prices yesterday.
- Finally, as noted above retailers are engaged in a price war as they try to hang on to market shares.
Add these three factors together and assume that the OBR are correct and wage growth will remain weak throughout 2012 and you have a recipe for inflation falling much faster than many observers expect.
Add the current indebtedness of UK households into that mix and their seeming desire to deleverage and you have the potential for a real deflation scare towards the end of the year.