UK inflation: on track to a 4% peak

On the road to 4% inflation: Although higher than expected inflation in January was due to a jump in food price inflation, which can be volatile, the big picture is that the disinflation process is stalling. The increase in CPI inflation from 2.5% yoy in December to 3.0% in January was above both the consensus forecast of 2.8% and our own estimate (2.9%). Services inflation has stalled at about 5% yoy for the past five months, and the elevated labour cost pressures highlighted by yesterday’s labour market release will make it difficult for it to fall much further this year. With energy prices about to start rising again, we think that the rise in inflation in January will prove the first step on a path to 4% CPI inflation by September.

Broad-based price pressures: Inflation in all major categories increased in January – see Chart 1. We expected the complete reversal of the slump in services inflation from 5.0% yoy in November to 4.4% in December. The return to 5.0% yoy in January was mainly due to a temporary drop in airfares reversing. The application of VAT to private school fees also put upward pressure on services price inflation as it raised up price growth in education services from 5.0% yoy to 7.5% yoy, a 9-year high. The big surprise compared to the BoE and consensus prediction was the jump in food price growth from 1.9% yoy to 3.1% yoy driven by larger annual price increases in almost all categories of food and non-alcoholic drinks. A rise in annual agricultural commodity price growth to a two-year high in January suggests that higher food price inflation will be sustained.

What next? The Bank of England’s (BoE’s) decision maker panel survey indicates that firms expect to raise prices by about 4% over the coming year, and the survey has a good relationship with core inflation, which jumped from 3.2% yoy in December to 3.7% in January (see Chart 2). Strong pay growth and the increase in employers National Insurance Contributions (NICs), a UK payroll tax, at a time when productivity is flatlining means that firms are facing a large increase in labour costs. Reasonable domestic demand will allow companies to pass much of the increase in costs they face onto customers in the form of higher prices. That is likely to cause the downward trend in services prices to stall. At the same time, energy prices are likely to switch from weighing on inflation to boosting it. Together, that is likely to push CPI inflation up to c4% in September and cause the BoE to take a long pause after lowering bank rate from 4.50% to 4.25% in May.

Andrew Wishart

+44 20 3753 3017

Berenberg
60 Threadneedle Street
London EC2R 8HP
United Kingdom

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