Costs and prices
consumer prices
producer output prices
producer input and commodity prices
import and export prices
The MPC looks at the prices of goods and services at different
stages of the production process to help it assess the inflation
outlook. Information on commodity, producer and retail prices
can tell us both about general inflationary pressure in the
economy and specific developments that might influence retail
price inflation in the future.
consumer prices 
We have already said a great deal about consumer prices. We
explained in the Policy Framework
section that the Government's inflation target is currently
specified in terms of the annual rate of change in the Consumer
Prices Index. We said that monetary policy is not aiming to
keep inflation exactly in line with the inflation target every
single month. Month to month, the actual rate of inflation will
tend to move up and down. In the Inflation
Outlook section, we discussed how the current rate of inflation
might be a poor guide to prospects for the rate of inflation
over the next two years or so.
the prices 'pipeline'
Consumer prices represent the final price paid by the
consumer. They can be thought of as the end of a 'pipeline'
of costs and prices. The final price will be made up of many
different components of cost as well as the retailer's profit
or margin. For retailers, the price of an item will have to
cover the cost of buying the goods from the producer, paying
staff their wages and paying for other services required such
as delivery, rents and electricity. A similar breakdown applies
to producers. This will include the cost of materials and components
that they purchase from other firms.
Prices at one stage of the pipeline become costs for the next
stage - for example, oil prices are a cost for petrol producers;
petrol prices are a cost for haulage companies; haulage prices
are a cost for retailers. The idea is a simplification and it
is not meant to imply that consumer prices are just the sum
of all the various costs in the pipeline. Prices are determined
by the interaction of supply and demand. If the cost of raw
materials rises, for example, producers or retailers might accept
lower profit margins rather than raise their prices. They are
more likely to do this if demand is weak or because of competition.
The degree of competition in markets can affect how much cost
increases are passed on to consumers.
The effects of prices in the pipeline do not work in just one
direction. For example, an increase in oil prices might show
up first as an increase in producers' material prices and then
feed through to consumer prices. But an increase in demand,
perhaps due to a rise in government spending, might first result
in higher consumer prices before higher demand puts pressure
on resources further down the pipeline, resulting in a rise
in oil and other material prices. The MPC monitors price developments
at all stages of the 'pipeline' to spot signals and clues about
demand and future inflation.
components of the CPI
Although we are interested in the overall rate of inflation,
there may be instances when price changes in individual, or
groups of, components of the inflation index contain useful
information. In order to understand movements in current consumer
price inflation and to assess the likely path of inflation in
the future, the MPC regularly monitors developments in the inflation
rates of different components. For example, some food prices
can be volatile, often reflecting factors like the weather.
These effects are usually temporary in nature, so they can obscure
the underlying trend in inflation from month to month.
We might even want to look at the price changes of individual
components of the CPI if the inflation rate rises or falls in
a particular month due to specific price movements. The Office
for National Statistics often draws attention to particular
items that have had a significant influence on inflation in
a particular month. You then need to decide whether the reasons
are specific to the item or items, or indicative of some wider
influence that may affect other prices over time. More generally,
the MPC pays particular attention to trends in inflation rates
for the 'goods' and the 'services' components of the CPI.
some prices go up - some prices go down
Individual prices are going up and down all the time.
If we were to look at the prices of every item within the CPI
then we probably would not glean very much information about
the overall situation. Rather, we would learn more about the
specific characteristics relevant to the markets for each product,
and changes in consumer tastes. Computer prices have tended
to fall over time as new technology has made new models better
and cheaper. Computer prices might fall whether overall inflation
is 2.0% or 5.0%. Conversely, some prices such as those for household
services, like plumbing, have tended to rise more quickly than
the overall rate of inflation. These observations do not add
much to our assessment of the inflation outlook. But if there
was a change in these established patterns - which might change
the inflation rate for a period - we would need to consider
them more closely and assess their significance.
goods and services prices inflation
Looking at the inflation rates for goods and services prices
can often tell us about the nature of the forces underlying
the current rate of inflation, and provide clues about the inflation
outlook.
Consumer goods prices account for around 55% of the Consumer
Prices Index and services prices account for around 45%. The
goods component includes much of what is sold in shops, and
other items, such as cars and petrol. The services component
includes things like bus fares, insurance premiums, cinema
ticket prices, electricity and hairdressers' prices.
On average, goods prices inflation has tended to be lower
than services prices inflation. This mainly reflects a higher
rate of growth of productivity in goods markets relative to
services markets. Goods are traded internationally to a greater
extent than services and capital equipment tends to replace
labour to a greater degree in the production of goods compared
with services.
So, if inflation is around 2.0%, we might expect to see goods
prices inflation below this rate and services prices inflation
above it. Of course, at any specific point in time, goods prices
inflation might be higher than services prices inflation - most
recently, following a depreciation of sterling in 1995, which
made imported goods more expensive.
domestically generated and imported inflation
Prices will reflect both domestic economic conditions and
also international influences, such as the exchange rate and
demand conditions in overseas economies, which can affect the
price of goods imported into the UK. One way of thinking about
overall inflation is as a combination of domestic inflation
and imported inflation. The UK economy is very open to international
trade and so domestically generated inflation corresponds to
the rate of inflation that would prevail in the absence of changes
in prices that are influenced by external factors. Goods prices
will be influenced by changes in the exchange rate to a greater
extent than services prices.
A fall in the exchange rate - a depreciation - will tend to
increase the level of prices, at least relative to what they
would otherwise be. This might mean that any downward pressure
on prices from weak demand could be offset to some extent, or
upward pressure from strong demand could be exacerbated. An
appreciation of sterling is likely to have the opposite impact
- reducing the level of prices.
So if changes in the exchange rate are influencing inflation,
we would need to assess what inflation might be once these effects
had worn off. This goes for any temporary influence on inflation,
although if changes in inflation affect inflation expectations
and, in turn, wage demands, these influences can prove more
persistent. It is the job of monetary policy to ensure that
this does not happen.
producer output prices
The prices charged by producers for finished products are
an important influence on consumer prices. They will be influenced
by the costs of production, including wages, and also the prices
of imports that feed into the production process. They will
reflect the balance between demand and supply in the same way
as consumer prices. There is a close relationship between changes
in producer price inflation and consumer price inflation, and
particularly consumer goods prices, though this will vary depending
on factors such as the level of demand.
We can monitor producer prices by looking at the Producer
Prices Index. Producer output prices reflect the prices charged
by manufacturers to other sectors such as retailing, business
services and construction. They will also include any taxes
and duties levied on manufacturers' prices, for example those
on fuels like petrol. Changes in duties set by the Chancellor
in the annual Budget can have an influence on the rate of inflation
for producer prices, as well as consumer prices. So we sometimes
also look at producer prices excluding tax effects to get a
better view of the underlying situation.
producer input and commodity prices
Price indices are also available for the materials used by
manufacturers - what are called producer input prices. Inputs
are materials such as timber, fuels, metals, and food materials.
Of course, one firm's input is another firm's output, so the
producer input price index also includes items like steel and
plastics. The producer input price index weights materials and
components according to their use as inputs by manufacturing
firms. Many basic materials are also included in indices of
commodity prices. Commodity price indices consist of what we
call primary products, such as oil and timber.
Producer input and commodity prices can rise and fall by large
amounts. Trends in material and commodity prices are usually
more volatile than the prices charged by manufacturers and retailers.
This has been particularly noticeable in the recent past when
consumer price inflation has been relatively low and stable.
Raw materials are only a part of manufacturers' total costs,
so large changes in these prices do not tend to lead to changes
in manufacturers' output prices of the same magnitude. They
are likely to have some impact, particularly if price changes
are large and manufacturers think they will be permanent. Large
one-off changes in prices of commodities like oil can have temporary
effects on consumer price inflation. But only if these effects
resulted in higher inflation expectations might any rise in
inflation be more persistent.
changes in commodity and material prices
Commodity and material prices are sensitive to changes
in demand and expectations about future demand. In the short
term, supply tends to be fairly fixed, particularly for commodities
which are grown - for example, rubber and wheat. If demand growth
is expected to rise, this might put upward pressure on prices
unless there are large stocks of commodities available to increase
supply in the short term. Similarly, if demand grows more slowly,
there will be excess supply and lower prices. Changes in commodity
and material prices can also reflect movements in exchange rates.
Many commodities that are traded internationally are priced
in US dollars so the price in pounds will reflect the £/$
exchange rate.
Large price changes for individual materials and commodities
can often reflect specific events, such as crop failures or
processing problems in particular markets or countries that
are important suppliers - for example, Brazil produces a large
part of the world's total coffee crop. The oil price is affected
by the amount that major oil producers agree to produce under
arrangements set by OPEC (the Organisation of the Petroleum
Exporting Countries).
import and export prices
The MPC also looks at import and export price indices to track
the effects of exchange rate changes and demand pressures in
both the UK and abroad, and how these might affect consumer
prices in the future. Exchange rate changes will lead to changes
in sterling import and export prices. If prices in foreign currency
terms do not change, then an appreciation of the exchange rate
will lower sterling prices.
The timing and extent of any fall in import and export prices
might depend on the strength of demand. If demand is strong,
importers might choose to increase their profit margins and
perhaps sacrifice some sales rather than reduce their prices
in sterling terms. Similarly, exporters might hold their prices
and sacrifice sales. If, on the other hand, demand is weak,
importers might reduce sterling prices instantly in order to
boost their sales. The MPC monitors export and import prices
alongside data on export and import volumes.
Key
data: costs and prices
Consumer Prices Index
producer output prices
producer input prices
commodity prices
oil prices
export prices
import prices
©2000-2009 Bank of England.
