Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
Can it really be the case that Downing Street is thinking of fixing the price of essentials at supermarkets? Reports suggest that a policy to ask supermarkets voluntarily to fix the prices of key food items is under consideration.
It wouldn’t be the first time that a policy idea has been leaked to gauge opinion before a decision is taken on whether to proceed. Even if the idea proves popular, it is best avoided.
While control of inflation falls under the remit of the Bank of England, the Government has made halving inflation this year one of the five promises on which it wishes to be judged. There is, though, only so much that the Government can do. This might explain its focus on price controls. Although inflation will decelerate, it is touch and go whether the headline rate will halve this year.
The annual rate of consumer price inflation peaked last October at 11.1 per cent. Its descent since then has been slow. The latest disappointment came last week, when April inflation fell less than expected. The annual rate of consumer price inflation (CPI) decelerated from 10.1 per cent in March to 8.7 per cent in April.
Core CPI – which excludes energy, food, alcohol, and tobacco – rose from 6.2 per cent in March to 6.8 per cent in April, its highest annual rate since March 1992. The stubbornness of core inflation has raised concerns that the UK might be forced into a recession by the higher interest rates that are needed to get inflation back under control.
The persistence of core inflation led markets to raise their expectation of where policy rates will peak. At their recent Monetary Policy Committee, the Bank of England raised the policy rate by 0.25 per cent to 4.5 per cent and, ahead of last week, the markets had not ruled out rates peaking at five per cent. Now, the market expects policy rates to peak around 5.5 per cent.
In turn, bond yields rose significantly, and are not far below the level they reached in the aftermath of the mini-Budget. The similarity between last autumn and now is the market’s concern on both occasions about inflation and their lack of confidence in the UK’s anti-inflationary policy stance – and that rates may have to rise.
The challenge raised by the latest inflation data is how serious the Bank is about achieving its inflation target. The US Federal Reserve has a dual mandate of low inflation and stable employment conditions. More recently, the importance of ensuring financial stability in the wake of the US banking crisis has also come to the fore.
By contrast, the Bank of England has a sole mandate: a two per cent inflation target. It is this that is at the heart of the market’s latest thinking on policy rates. The belief is that if the Bank is committed to its target then it will need to tighten further.
Perhaps the Government’s focus should be on holding the Bank to account – without undermining its independence – rather than going down the route of price controls.
Of course, no government can be indifferent to prices or incomes. They are central to the economy. The Government, too, is a large employer. Furthermore, it influences or sets prices such as at public utilities. Yet price controls are not a new policy tool. From 1960-1979 prices and incomes policies were central to attempts to control the economy and that didn’t work well.
In a competitive industry such as the supermarkets, such controls make no sense. There are many price comparison sites about supermarkets showing the variations in the price of similar goods. All too often, the price of essentials like milk are kept low anyway, to entice customers in.
That is not without its wider consequences, since the flip side of such low prices is that suppliers such as milk producers find it hard to make their business models work. Indeed, once prices are fixed it removes the competitive element essential for ensuring enough supply to meet demand at a market clearing price.
The rise in food prices over the last year has already focused attention on food security and the need for affordable prices. It has also highlighted the fragile supply chain. With margins tight or prices frozen, it is often the farmers or suppliers who absorb the costs. This limits their ability to remain in business, never mind invest for future production. A further complication is how price controls might impact the relationship between the big supermarkets and smaller shops who may lack the ability to absorb such interventions.
Currently, the role of the Competition and Markets Authority is central to ensuring that markets work property to the benefit of consumers. Plus, targeted help can be provided, to those in need, as was the case during the energy crisis. That’s what we should stick to – not a return to bureaucratic price controls.
Earlier this year, the French, despite their large agricultural economy, announced an opt-in price control policy. That was to counter the rampant food price inflation which has afflicted western European economies, including the UK, in recent years.
UK food prices rose by an annual rate of 19.1 per cent in April. The cumulative increase in food price between December 2019 to April 2023 was 26.3 per cent for the UK and compares with 22 per cent for Italy, 22.8 per cent for France and 33 per cent for Germany.
For the euro area, the rise was 26.7 per cent and for the EU27 30.4 per cent. Previous bouts of food price inflation, here or elsewhere, suggest a strong link with energy prices, which are a key cost in the food production cycle impacting feed and fertiliser costs. Now, food price inflation appears close to a peak and looks set to decelerate.
The surge in inflation that we have seen in recent years has been triggered by two factors: supply side factors linked to the pandemic and then exacerbated by the War in Ukraine, and inappropriate monetary policy.
Recently, I testified on monetary policy before the Treasury Select Committee. I described Quantitative Easing and in turn monetary policy as the good, the unnecessary and the bad. The good was the policy response in the aftermath of the 2008 global financial crisis, when monetary policy easing alongside fiscal stimulus prevented a depression.
The unnecessary was the prolonged period of cheap money for much of the last decade. This fed many economic and financial problems from which we are now suffering, including inflation itself.
Meanwhile, the bad was the monetary policy easing that followed the pandemic. As time progressed, it became clear that this was a major supply-side shock and also that fiscal policy was being eased considerably. In those circumstances monetary policy should have been tightened, not loosened. The Bank’s response exacerbated the inflation shock.
Now, both factors that led to this surge in inflation have been reversed. Thus, inflation is decelerating. Importantly, neither excess demand nor higher wages triggered this inflation shock. But once inflation rises, the inflation dynamics can change, and it becomes hard to predict. Thus, attention is on second round effects, including the extent to which costs rise, including wages, and whether firms raise prices to maintain or to boost margins.
Inflation looks set to decelerate over the next year, but the rate at which it eventually settles may be three per cent to 4 per cent, and thus above the two per cent target. Tackling inflation will require more than price controls.