Reasons for high Inflation in UK

Inflation Falling

The UK consumer prices, measured by the Consumer Prices Index (CPI), experienced a 4.0% increase in December 2023 compared to the same month a year earlier. This marked a slight uptick from the 3.9% recorded in November. The primary contributing factor to this increase was identified as a rise in tobacco duty during the specified period. The Consumer Prices Index serves as a key metric for assessing changes in the average prices paid by consumers for goods and services, providing insights into inflationary trends within the economy.

In December, “core” inflation, a metric that excludes the volatile energy and food components of the Consumer Prices Index (CPI), remained steady at 5.1%. This figure was unchanged from November but showed a slight decrease from the 5.7% recorded in October. “Core” inflation is a measure that provides insight into underlying inflationary trends by excluding the more fluctuating prices of energy and food items.

Additionally, services inflation, considered a gauge of domestic inflationary pressure, experienced a marginal increase from 6.3% in November to 6.4% in December. Earlier in 2023, both “core” inflation and services inflation had reached 31-year highs, underlining a period of notable inflationary pressures within the economy. These metrics play a crucial role in assessing the overall economic climate and informing policymakers about potential inflationary risks.

A decrease in the inflation rate, or a situation where inflation is slowing or falling, indicates that prices are increasing at a slower pace compared to a previous period; it does not imply that prices are declining. To illustrate, if the annual inflation rate declines from 10% to 5%, it signifies that prices are still 5% higher than they were in the corresponding period a year earlier.

It’s crucial to understand that a slowing inflation rate doesn’t imply an actual reduction in price levels but rather a moderation in the rate of price increases.

Looking ahead, figures for inflation in January 2024 are scheduled to be released by the Office for National Statistics on 14 February. These statistics play a vital role in assessing the economic landscape, providing insights into the overall price movements and helping policymakers make informed decisions based on inflationary trends.

Inflation falling further in 2024

The annual inflation rate in the UK is anticipated to keep decreasing throughout 2024, although the decline is expected to be more gradual compared to the previous year. This is attributed to factors such as lower energy prices and a decrease in inflation related to consumer goods and food.

Economists surveyed by the Treasury in the first half of January 2024 provided an average forecast, suggesting that inflation is expected to average 2.2% in the fourth quarter (Q4) of 2024. This indicates a consensus among economists regarding the trajectory of inflation for that period.

The Bank of England also shares the expectation of a continued decline in inflation. In its latest set of forecasts published in early November 2023, the Bank projected the Consumer Prices Index (CPI) inflation rate to average 3.1% in Q4 2024.

Additionally, the Office for Budget Responsibility (OBR), in forecasts released alongside the Autumn Statement, expressed an expectation that inflation would average 2.8% in Q4 2024. These forecasts from different entities provide varying estimates, reflecting the complexity of predicting economic indicators.

It’s worth noting that these forecasts are subject to various factors, including economic conditions, global events, and government policies, which can influence the actual trajectory of inflation.

The inflation rate is commonly represented as the percentage change in consumer prices compared to the prices one year earlier. To illustrate, the most recent data would compare prices in December 2023 with those in December 2022.

This calculation implies that any alterations in prices that occurred more than a year ago, specifically before December 2022 in this instance, no longer contribute to the annual inflation rate. This phenomenon had the effect of causing the inflation rate to decline during 2023, as certain past price increases, particularly the significant hikes in energy bills in 2022, are excluded from the annual comparison. This process is expected to persist to a lesser extent in early 2024, contributing to the overall inflation rate dynamics.

Understanding the Drivers Behind High Inflation:

The initial phase of the increase in inflation was primarily attributed to international factors, which included:

1. Strong Global Demand for Consumer Goods:
   • The COVID-19 pandemic and associated lockdowns led to a surge in global demand for consumer goods. As economies reopened, there was a heightened desire for various products, contributing to increased demand.
2. Supply Chain Disruption:
   • The pandemic-induced disruptions to global supply chains played a significant role. Delays in production, transportation bottlenecks, and other supply chain issues led to shortages of certain goods, putting upward pressure on prices.
3. Soaring Energy and Fuel Prices:
   • Energy and fuel prices experienced a notable increase, driven in part by geopolitical events. The full-scale invasion of Ukraine by Russia in February 2022 had a substantial impact on energy markets, contributing to a rise in prices globally.

Given the UK’s status as a large net importer of goods, including energy, these global factors had a direct influence on consumer prices in the UK. The interconnectedness of the global economy meant that events and trends in other parts of the world could have significant repercussions on inflation and economic conditions domestically. The initial phase of the inflationary increase reflected the complex interplay of these international dynamics.

lthough global factors initially fueled high inflation, there has been an acceleration in price increases in various sectors of the domestic economy. This acceleration is attributed, in part, to robust pay growth. Labor costs constitute a significant portion of expenses for many firms, especially those in the services sectors.

The strong growth in wages and labor costs can contribute to inflationary pressures domestically. When businesses experience increased labor costs, they may pass these additional expenses on to consumers in the form of higher prices for goods and services. This phenomenon is particularly noticeable in service-oriented industries where human capital plays a substantial role.

In summary, the shift from global factors to domestic elements, such as strong pay growth affecting labor costs, has become a notable driver of inflation within the domestic economy. This intersection of global and domestic factors underscores the complexity of the forces influencing inflationary trends.

Houthi rebel attacks on shipping in Red Sea

Recent disruptions to shipping traffic in the Red Sea and Suez Canal, attributed to Houthi rebels in Yemen, have led to increased shipping costs and the rerouting of many ships to longer and more expensive routes around the southern tip of Africa. This situation has the potential to elevate input costs for certain products being imported into the UK.

The prevailing consensus, however, is that the impact of these disruptions remains highly uncertain and contingent on future events in the Red Sea and the broader Middle East region. The potential inflationary effects arising from increased shipping costs may also take some time to manifest in the prices faced by consumers. The complexity of geopolitical events and their repercussions on global trade underscores the challenges in accurately predicting and assessing the economic impacts in the near term.

Consumer Relief as Food and Energy Inflation Eases:

Food prices experienced a sharp increase in 2022 and 2023 due to global supply chain disruptions and the impact of Russia’s full-scale invasion of Ukraine, causing input costs for food producers to rise. In December 2023, UK food and non-alcoholic drink prices, as measured by the Consumer Prices Index (CPI), were 8.0% higher compared to the previous year. This reflected a decline from the peak observed in March 2023, where food prices saw the highest rate of increase (19.1%) since 1977. Over the two-year period from December 2021 to December 2023, food prices surged by 26.2%, surpassing the rate of increase observed in the preceding 13 years from July 2008 to December 2021.

Another significant contributor to high inflation was the increase in energy prices, including household energy tariffs and road fuel costs in 2022. Gas prices reached record levels after Russia’s invasion of Ukraine, and electricity prices, linked to gas prices, followed a similar trend. A notable spike in prices occurred in April 2022, but this annual increase has since ‘dropped out’ of the inflation figures.

To address rising energy costs, the then Prime Minister announced the introduction of the Energy Price Guarantee (EPG) on 1 October 2022, capping typical consumption at £2,500 a year. This move limited increases in typical bills to 27% in October 2022. The EPG became less generous in July 2023, increasing to £3,000 a year. However, a fall in the price cap in July 2023 meant that the EPG no longer set maximum prices, leading to a decrease in consumer bills. The price cap fell again in October 2023.

Oil prices surged following Russia’s invasion of Ukraine in 2022, subsequently declining in the latter half of 2022 and the first half of 2023. UK road fuel prices peaked at new record levels in July 2022, gradually decreasing throughout the following year before experiencing an increase again in late summer 2023.

Rising Prices, Shrinking Pockets: The Household Impact of High Inflation:

Global consumer price inflation experienced an upward trajectory in much of the world throughout 2021 and 2022, reaching its peak in many economies in late 2022. However, there has been a decline in the annual rate of inflation observed in 2023. The pace of this disinflationary period has varied among countries.

As of December 2023, the annual inflation rate in the UK stood at 4.0%, which was lower than the rates in France (4.0%). It was similar to Germany (3.8%), but above the Eurozone average (2.9%), the United States (2.5%), and Italy (0.5%). These figures illustrate the diversity in inflationary trends across different countries, highlighting variations in economic conditions, policy responses, and other contributing factors influencing each nation’s inflation rate.

Navigating Economic Turbulence: How Government Policies Impact Household Finances:

1. Boost for Beneficiaries: DWP Benefits Set to Rise by 6.7% in April 2024:
   • The Department for Work and Pensions announces a 6.7% increase in benefits linked to inflation from April 2024, aligning with the annual CPI inflation rate.
2. Pension Payouts Soar: Basic and New State Pensions to See 8.5% Increase in 2024/25:
   • Pensioners rejoice as the government announces an 8.5% increase in the basic and new State Pensions for the fiscal year 2024/25, in line with average earnings growth.
3. Energy Price Guarantee: Households Set to Save £1,500 as EPG Caps Energy Costs:
   • The Energy Price Guarantee caps household energy costs, leading to potential savings of around £1,500 between October 2022 and June 2023, according to government estimates.
4. Government’s Generosity: Cost of Living Payments Benefit Various Recipients in 2023/24:
   • The government rolls out cost of living payments, with varying amounts allocated to different recipients, including households on means-tested benefits, pensioner households, and people on non-means-tested disability benefits.
5. Collaborative Support: Chancellor, Lenders, and FCA Unite to Offer Mortgage Relief on June 23, 2023:
   • On June 23, 2023, the Chancellor, principal lenders, and the Financial Conduct Authority collaborate to provide support measures, offering relief to individuals struggling with mortgage payments.

Housing Affordability Challenges: Surge in Interest Rates Leads to Escalating Mortgages and Rents:

• The Bank of England increased interest rates in an attempt to bring the inflation rate back to its 2% target.
• Interest rates were raised consistently at 14 consecutive policy meetings, starting from 0.1% in December 2021 and reaching 5.25% in August 2023.
• In September, November, and December 2023, the Monetary Policy Committee (MPC) opted to keep interest rates steady at 5.25%.
• The upcoming MPC meeting results will be disclosed on 1 February, with financial markets and most economists not anticipating further interest rate increases. Attention has shifted to potential rate cuts given the subdued economic growth outlook.
• Financial markets, as of 18 January, are anticipating rate cuts of approximately 1 to 1.25 percentage points, potentially lowering rates to 4-4.25% by the end of the year.
• The impact of higher interest rates has led to increased borrowing costs for households, particularly evident in the sharp rise of mortgage interest rates from historically low levels. Approximately 1.6 million households with fixed-rate mortgages expiring in 2024 are facing higher mortgage costs. Additionally, rental prices have experienced upward growth in recent years.