Commodity price inflation - a key issue in 2011

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Today, EEF released Economic Prospects 2011 containing our views on what 2011 is likely to hold for the UK economy and manufacturing. One of the key issues we identified was the pressure rising input prices are likely to put on manufacturers, inflation and overall economic growth. Indeed, the lead article in today's FT states that Cameron sees a threat from rising inflation.

December's manufacturing PMI showed that a record balance of companies reporting increased cost pressures. Commodity prices rose considerably in 2010 with metals, textiles and wheat prices most strongly affected. Copper prices have hit all-time highs on the London Metal Exchange in five of the last seven months. In recent months oil prices have also begun to climb, and have been edging closer to $100 per barrel in the last few weeks.

Although some companies pass on cost rises directly through contractual arrangements, many manufacturers have so far held back on price rises; for these companies, margins have come under increasing strain. As a result, our Business Trends survey showed a considerable jump in the number of companies planning to raise prices.

We expect rising input costs to affect companies for much of 2011. The strong growth in emerging economies that has so far sustained the rebound in global demand is likely to cause persistent pressures on commodity prices. In addition, should the Chinese renminbi be allowed to appreciate – and there are increased demands on the Chinese government to allow this – then the price of dollar-denominated commodities will also rise accordingly.

All of this will be causing concern for the Monetary Policy Committee. With inflation now forecast to remain above target for 2011 (partly as a result of the VAT rise) there will be increased pressure to raise interest rates. However, the recovery remains fragile, and with the austerity measures beginning to bear down on employment and domestic demand, the Bank will also be wary of stifling growth.

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