Inflation hit the BOEs 2%, yet the MPC still refused to cut rates. They signalled to services inflation being the reason. Is this a good enough reason?

Much like my earlier posts last year and this year, this number will go down. Why? Well, the slow in inflation from goods has a lag effect, meaning it takes longer to feed through into services!

Generally, it can take several months to a year for the effects to be fully realized. A phrase used to describe this is ‘Cost Pass-Through Delays’: Service providers may take time to adjust their prices in response to lower input costs. This delay can be due to existing contracts, price-setting behaviour, and the time it takes to realize and assess the impact of cost changes.

The example I’m going to use is Lumber/Wood Costs and Construction Services:

Lower raw material costs (goods) (in this case Lumber) can reduce construction services costs.

However, existing contracts and project timelines can delay the reduction in service prices. It might take 6-12 months for the lower material costs to be reflected in new project pricing. Below, I have used a real life example and downloaded the historical data of Lumber and Wood prices from the FED, as well as the construction services PPI. I then used Python to illustrate the lag effect these raw material prices had against construction services prices on the chart below:

While correlation of course doesn’t mean causation, I think this illustrates quite well the presence of a lag effect, where service prices adjust gradually over time in response to changes in input costs. The correlation increases with lag, peaking at specific points, demonstrating the delayed but eventual adjustment of service prices to lower input costs.

On a personal note, it was great to use Python for the first time using readily available data from the FED to create this chart!