Tight profit margins fuel fears of inflation


One of the great unknowns in forecasting inflation over the next few years is what will happen to the gap between the increase in prices manufacturers pay for materials and labour and the prices retailers pass on to customers.

According to the Bank of England's quarterly Inflation Report, released yesterday, this gap has yawned wide open during the past two years because of the dual nature of the recovery: the sunny fortunes of sectors involved in international trade and the clouds overhanging the UK economy.

While manufacturers have faced steep increases in their costs because of higher commodity prices, the fall in sterling and leap in import prices, retailers have not been able to pass higher prices on because of weak demand. Somewhere in the middle profit margins have been squeezed. They have probably now been squeezed as much as possible. Materials costs have been rising at double-digit rates since late last year, accompanied by only a gentle upward drift in retail prices.

Some details of precisely what is happening along the inflation pipeline were set out in the Inflation Report and have also been charted in a recent paper by City economists at UBS. According to the Bank of England, labour costs per unit of output account for about half of manufacturers' costs; materials and fuels a quarter, imports of finished manufactures a tenth, and services the rest. The total import content of non-labour costs is nearly 45 per cent. Unit wage costs fell throughout 1994 and rose in the first quarter of this year.

The most intense pressure, however, has come from materials and fuels, whose costs rose 11.3 per cent in the year to the second quarter and contributed 2.5 percentage points to a 3.6 per cent increase in unit costs excluding labour. The next biggest contribution came from prices of imported finished manufactures. By contrast, the cost of bought-in services was flat in the 12 months to June.

The impact has been to take growth in total costs in manufacturing up to about 5 per cent year-on-year, in marked contrast to the early part of last year, when costs fell slightly.

The rise in industrial costs has led manufacturers to increase prices at the factory gate, but at a slower rate, putting pressure on margins. In the year to June factory-gate prices were up 4.2 per cent. Excluding volatile food, drink, tobacco and petroleum products, underlying prices increased 4.8 per cent, the highest in more than four years. However, the rises have been showing signs of moderating

The pressure on margins further down the distribution chain has generally been more intense. Retail price inflation has risen from a trough of 2.2 per cent last September to 3.5 per cent in June. During the same months producer output price inflation has climbed from 2.3 per cent to 4.2 per cent, and up from 2.1 per cent to 4.8 per cent on the underlying measure.

According to the UBS study, distributors' margins, which soared during the 1980s, have fallen from their 1990 peak. The data indicates the fall has been modest, although distribution includes hotels, restaurants and wholesalers as well as retailers. For retailers alone the squeeze on profit margins has been more severe. The Bank of England puts the rise in retail costs in the year to the first quarter at 4 per cent, with a 1.9 per cent increase in underlying prices.

The downward trend in retail margins has lasted now for two and a half years. How much longer can margins fall, both in industry and on the high street? There are signs it is ending. Verdict, the retail researchers, reported earlier this week that the big supermarket chains have been rebuilding their margins during the past three months.

The stores have passed on more of the inflationary pressure to their customers, opting for loyalty schemes rather than price competition.

The Inflation Report concludes: ''Firms may try to restore domestic margins by increasing prices instead of bearing down harder on costs.'' Mervyn King, the Bank of England's chief economist, says it would not be surprised to see a cyclical recovery in margins.

The danger in this is that it removes a safety valve for containing the inflationary impulse of higher commodity prices and the weak exchange rate. There were no subsequent second-round effects from the pound's fall in 1992 because profit margins were at a peak and had plenty of room to fall. According to Mr King, the fact margins have been squeezed as much as they can ''must increase the risk of second-round effects on prices and wages''. That would mean higher inflation in the short run, and over the longer term too if monetary policy were not tightened sufficiently.

Profit margins are not the only influence on inflation. But they are important because the end of the profit squeeze on retailers and manufacturers selling to the home market means the Bank and the Chancellor of the Exchequer cannot dismiss price increases along the inflation pipeline as a one-off effect of the weak pound. This is not 1992. There is a risk this time that imported price rises will metamorphose into a classic British inflation cycle.

The Banksy image in Folkestone before it was vandalised
Life and Style

Sales of the tablet are set to fall again, say analysts

football West Brom vs Man Utd match report: Blind grabs point, but away form a problem for Van Gaal
Arts and Entertainment
Gotham is coming to UK shores this autumn
tvGotham, episode 2, review
Arts and Entertainment
Bloom Time: Mira Sorvino
tvMira Sorvino on leaving movie roles for 'The Intruders'
Brian Harvey turned up at Downing Street today demanding to speak to the Prime Minister

Met Police confirm there was a 'minor disturbance' and that no-one was arrested

Arts and Entertainment
George Lucas poses with a group of Star Wars-inspired Disney characters at Disney's Hollywood Studios in 2010

George Lucas criticises the major Hollywood film studios

Chris Grayling, Justice Secretary: 'There are pressures which we are facing but there is not a crisis'

Does Chris Grayling realise what a vague concept he is dealing with?

Life and Style
A street vendor in Mexico City sells Dorilocos, which are topped with carrot, jimaca, cucumber, peanuts, pork rinds, spices and hot sauce
food + drink

Trend which requires crisps, a fork and a strong stomach is sweeping Mexico's streets

ebooksAn unforgettable anthology of contemporary reportage
Life and Style
The charity Sands reports that 11 babies are stillborn everyday in the UK
lifeEleven babies are stillborn every day in the UK, yet no one speaks about this silent tragedy
Blackpool is expected to become one of the first places to introduce the Government’s controversial new Public Space Protection Orders (PSPOs)

Parties threaten resort's image as a family destination

Life and Style
Northern soul mecca the Wigan Casino
fashionGone are the punks, casuals, new romantics, ravers, skaters, crusties. Now all kids look the same
Life and Style

I Am Bread could actually be a challenging and nuanced title

Nigel Farage has backed DJ Mike Read's new Ukip song
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Customer Service Executive / Inbound Customer Service Agent

£18 - 23k + Benefits: Guru Careers: We are seeking a Customer Service Executiv...

ASP.NET Web Developer / .NET Developer

£60 - 65k + Benefits: Guru Careers: We are seeking a ASP.NET Web Developer / ....

Operational Risk Manager - Asset Management

£60,000 - £80,000: Saxton Leigh: Our client is an leading Asset Manager based...

Project Coordinator - 12 month contract

£27000 - £32000 Per Annum: Clearwater People Solutions Ltd: Our large charity ...

Day In a Page

Oscar Pistorius sentencing: The athlete's wealth and notoriety have provoked a long overdue debate on South African prisons

'They poured water on, then electrified me...'

If Oscar Pistorius is sent to jail, his experience will not be that of other inmates
James Wharton: The former Guard now fighting discrimination against gay soldiers

The former Guard now fighting discrimination against gay soldiers

Life after the Army has brought new battles for the LGBT activist James Wharton
Ebola in the US: Panic over the virus threatens to infect President Obama's midterms

Panic over Ebola threatens to infect the midterms

Just one person has died, yet November's elections may be affected by what Republicans call 'Obama's Katrina', says Rupert Cornwell
Premier League coaches join the RSC to swap the tricks of their trades

Darling, you were fabulous! But offside...

Premier League coaches are joining the RSC to learn acting skills, and in turn they will teach its actors to play football. Nick Clark finds out why
How to dress with authority: Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear

How to dress with authority

Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear
New book on Joy Division's Ian Curtis sheds new light on the life of the late singer

New book on Ian Curtis sheds fresh light on the life of the late singer

'Joy Division were making art... Ian was for real' says author Jon Savage
Sean Harris: A rare interview with British acting's secret weapon

Sean Harris: A rare interview with British acting's secret weapon

The Bafta-winner talks Hollywood, being branded a psycho, and how Barbra Streisand is his true inspiration
Tim Minchin, interview: The musician, comedian and world's favourite ginger is on scorching form

Tim Minchin interview

For a no-holds-barred comedian who is scathing about woolly thinking and oppressive religiosity, he is surprisingly gentle in person
Boris Johnson's boozing won't win the puritan vote

Boris's boozing won't win the puritan vote

Many of us Brits still disapprove of conspicuous consumption – it's the way we were raised, says DJ Taylor
Ash frontman Tim Wheeler reveals how he came to terms with his father's dementia

Tim Wheeler: Alzheimer's, memories and my dad

Wheeler's dad suffered from Alzheimer's for three years. When he died, there was only one way the Ash frontman knew how to respond: with a heartfelt solo album
Hugh Bonneville & Peter James: 'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'

How We Met: Hugh Bonneville & Peter James

'Peter loves his classic cars; I've always pootled along fine with a Mini Metro. I think I lack his panache'
Bill Granger recipes: Our chef's heavenly crab dishes don't need hours of preparation

Bill Granger's heavenly crab recipes

Scared off by the strain of shelling a crab? Let a fishmonger do the hard work so you can focus on getting the flavours right
Radamel Falcao: How faith and love drive the Colombian to glory

Radamel Falcao: How faith and love drive the Colombian to glory

After a remarkable conversion from reckless defender to prolific striker, Monaco's ace says he wants to make his loan deal at Old Trafford permanent
Terry Venables: Premier League managers must not be allowed to dictate who plays and who does not play for England

Terry Venables column

Premier League managers must not be allowed to dictate who plays and who does not play for England
The Inside Word: Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past

Michael Calvin's Inside Word

Brendan Rodgers looks to the future while Roy Hodgson is ghost of seasons past