View from City Road: Inflation warning in the kitchen

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The Independent Online
Householders are stockpiling coffee, a string of British companies have been complaining this week about rising raw material prices and yesterday markets worldwide suffered another bout of inflation jitters.

It would be far-fetched to compare this with the early 1970s, when kitchen cupboards were also groaning with hoards of Nescafe as coffee and most other commodity prices rose, including oil. That signalled the start of an inflationary cycle that is only now - if we are lucky - working itself out of the system.

Much has changed for the better in the meantime, especially the determination of governments to get to grips with inflation. But it is nevertheless hard to forget history, or for the markets to brush aside completely the new inflationary pressures from commodity prices. Sadly, hoarders have probably got their timing right.

Commodity prices have already risen 6.8 per cent this year, according to the index published by the investment bank Goldman Sachs. But they have a lot further to go. For one thing, prices are starting from an extremely depressed base. At the end of last year prices of some agricultural commodities were near all-time lows. At the end of March this year over half the constituents of the Goldman Sachs index were still trading at prices lower than the cost of production.

Although economic recovery in the US and Britain has started to raise demand for raw materials, other industrial countries are lagging further behind in the business cycle. The pressure of higher demand from continental Europe and Japan has yet to feed through.

There is an extra structural reason for expecting the commodities upswing to continue. Newly industrialised countries such as Korea, and rapidly industrialising ones such as China, are likely to use a steadily increasing amount of basic materials.

Higher input costs have one of two unpalatable implications. One is that companies cannot pass the increases on, so they suffer a squeeze on profit margins unless they can make compensating productivity gains.

So far they have managed to improve efficiency. But fears about how long this will last are likely to keep the stock market on edge.

Alternatively, if firms can pass on higher costs - like Arjo Wiggins Appleton, the paper maker, which said this week it had passed a 45 per cent rise in pulp costs to customers - that means, eventually, higher inflation.

Kilos of coffee in the cupboard do not herald retail price inflation at 1970s rates. But if you had to choose one indicator apart from domestic growth to forecast British inflation, it would be commodity prices. Like the stirrings of house-price inflation in parts of the South-east, this is something to watch and worry about.