Economics:Glanbia this week increased the prices of its dairy and food products by an average of more than 10 per cent. Confirming the low double-digit increases, the publicly quoted food group said that it could not rule out the possibility of further price rises later this year if raw material costs continued their rapid ascent, writes Paul Tansey.
Glanbia's main brands include Avonmore milk and butter, Kilmeaden cheese and the Yoplait range.
These increases follow a year in which Irish food prices increased by 6.6 per cent. In the 12 months to December 2007, the Consumer Price Index shows that retail milk prices rose by 20.3 per cent, while the price of bread jumped by 19.7 per cent. Food accounts for 10.8 per cent of all consumer spending in the Republic.
In microcosm, Glanbia's decision illustrates why European interest rates will not track US interest rates all the way downwards this year. Fears of rising inflation will act as a brake on the scale of interest rate cuts within the euro zone.
On Tuesday, the Federal Reserve Board, the US central bank, reduced US interest rates by three-quarters of a percentage point, the deepest cut for a quarter of a century. The key federal funds rate was lowered from 4.25 per cent to 3.5 per cent. Since the Fed started easing monetary policy in September, the federal funds rate has been reduced by 1.75 percentage points, from 5.25 per cent to the current 3.5 per cent.
The decision to cut the cost of US money was taken at an unscheduled meeting of the Federal Open Market Committee before Wall Street opened on Tuesday. While the move took markets by surprise, it was forced by events. The $150 billion expansionary fiscal package unveiled by US president Bush last Friday was swiftly interpreted as an insufficient rebuff to recession.
Markets panicked as a result. Wall Street, closed for holiday honouring Martin Luther King, missed the global market meltdown on Monday. In the absence of the Fed's decision, the New York market would have gone through the floorboards at the opening bell. As it was, the interest rate cuts managed to contain the day's losses to respectable levels.
Even taken in conjunction with Bush's expansionary tax-cutting package, the Fed was under no illusion that its significant easing of monetary policy would prove sufficient to avert a recession in the US.
Having announced the cuts, it stated that "appreciable downside risks to growth remain", adding that it "will act in a timely manner as needed to address those risks". In other words, if the going gets tougher, the Fed will continue cutting.
After a brief respite, stock markets were on the slide again by Wednesday. The weakening tenor of market sentiment reflects three separate strands of thinking: a growing belief that the US economy is still edging into recession; an increasing realisation that what's bad for the US economy is bad for the global economy; and finally, a grudging acknowledgement that the European Central Bank (ECB) will not reduce interest rates as far or as fast as the cuts already seen in US rates.
When the subprime lending crisis broke in the summer, the ECB responded quickly, aggressively and correctly, by pouring vast quantities of liquidity into European money markets. However, it has remained wholly inflexible on the interest rate front. The ECB's key interest rate has remained stationary since the summer at 4 per cent. The ECB's intransigence on interest rates is explained by four factors.
First, the primary, indeed the only, objective of the ECB is to maintain the purchasing power of the euro by ensuring price stability. ECB monetary policy aims at achieving broad price stability in the euro area by keeping annual inflation rates below, but close to, 2 per cent in the medium term.
The policy implication is clear. Where inflation, as measured by the Harmonised Index of Consumer Prices (HICP), persistently exceeds 2 per cent, there is a prima facie case for tightening monetary policy by raising interest rates.
A strict interpretation of the ECB code would suggest that euro-zone interest rates should have risen already. For euro-zone inflation rates have been trending upwards over the past year. The annual rate of HICP inflation in the euro zone reached 3.1 per cent in December, compared with 1.9 per cent in the 12 months to December 2006. Nor are there any signs that inflationary pressures are abating. Given the ECB's narrow remit, it is difficult to sustain an argument for interest rate cuts against this background of rising inflation.
Second, the ECB is increasingly concerned that accelerating inflation will raise inflationary expectations and spill over into the labour market. When inflation starts to pick up, people begin to anticipate further inflation.
They build these expectations into their own economic behaviour. In particular, they seek to embed their expectations of future inflation into contracts, particularly wage contracts. Subsequent wage/price spirals can be extremely difficult to break and inflation can become institutionalised all too easily.
Third, for the present, the ECB still does not foresee any real threat to euro-zone economic growth. While conceding that the targeted growth rate of 2 per cent will now be more difficult to achieve, the bank contends that actual expansion is broadly in line with potential output growth. It follows that there is no need for an interest rate cut.
Finally, the ECB has no explicit role in promoting growth in the euro zone. Unlike the Fed, it does not countenance monetary activism as a means of steering the economy through peaks and troughs. Implicitly, the ECB, like its predecessor the German Bundesbank, sees price stability and the low interest rate environment such stability engenders, as the surest route to sustained economic expansion.
For the ECB, inflation is the ultimate enemy of economic promise. As a result, while the markets have already priced in ECB interest rate reductions this year, the scale of those cuts will be much more limited than in the US for as long as inflation persists at high levels.
