UK Inflation Eases to 3.1% But More Price Hikes Already Baked In

UK inflation fell back slightly in September to 3.1% from 3.2% in August, but the apparent slowdown was accounted for by the Eat Out to Help Out scheme distorting the picture.

Compared with September last year the cost of eating out was less because of Eat Out to Help Out scheme introduced by the government to subsidy restaurant meals.

But the respite will be short-lived, both because of price rises already taking place at the producer end of the production process and also because prices in the five months after September 2020 were subdued and we already know this will not be the case this year.

Office for National Statistics show that factory gate prices were 6.7% higher in September from 6% in August, while prices for raw materials and other goods coming into factories were up 11.4% on a year ago.

Wholesale energy prices to pass through to households

Energy prices will continue to rise, notwithstanding the turn lower in gas prices yesterday as the mild weather in Europe continues and wind power begins to increase its contribution to the energy mix.

The removal of the energy price cap and of the lower 5% VAT for hospitality have both added to prices. The energy price cap was lifted 12%.

In fact, all categories of goods and services saw higher prices, with the exception of the restaurant and hotel sector, which was the only area having the impact of lowering prices.

UK inflation could hit 6% in 2022

Inflation breakeven for next year – which is a market derived estimate of inflationary expectations – is already at 6%, way above the Bank of England 2% target.

Some commentators think inflation cold reach 4% before year’s end as the gas price increases in the wholesale markets pass through to consumers.

Others, such as Samuel Tombs, an economist at Pantheon Macroeconomics, thinks energy prices could see UK CPI top out at 4.7% in April 2022 but doesn’t see any significant evidence of a spread to core consumer services as yet.

BoE will still raise rates in November or December

Analyst James Smith at ING thinks CPI will peak at 4.5% in April. He also concurs with the consensus among economists and analysts that the slightly weaker inflation data will not stop the Bank of England increasing interest rates as soon as November.

However, Smith suggests that the market pricing in a rate above 1% may not necessarily be born out as growth concerns emerge.

“Governor Bailey’s recent comments have made it clear that the Bank of England is gearing up for an imminent rate rise, most likely at the November meeting. It will probably be followed by another 25bp rate hike next spring or summer.

“But there’s a difference between this, which could perhaps be viewed as a hedge against the rise in inflation expectations Governor Bailey is concerned about, and the series of rate hikes markets are now expecting, taking Bank rate above 1%,” Smith commented.

Andrew Bailey, bank governor, made crystal clear last week the MPC “will have to act” to hold back inflation. The BOE is worried that inflation might become embedded through them the mechanism of a wage-price spiral in which workers demand higher wages to account for higher prices, which in turn raises costs for employers, leading companies to raise their prices..

Forex traders are predicting that base rate will edge up from 0.1% to 0.25% in November or possibly December.

Inflation eats into real wages, threatens recovery

Inflation is a threat to growth because of its impact on consumer spending power and sentiment as it easts into real wages.

Although unemployment is falling, many households will not be able to increase their income to pay for higher energy and food prices, forcing discretionary spending cuts to take up the slack, which will weaken aggregate demand in the economy.

Low income households also have to contend with a £20 a week cut in benefits.

The extent of food price inflation was laid bare by Ian Wright, head of the Food and Drink Federation, in comments he made to a House of Commons select committee of MPs yesterday, when he described price rises as “terrifying”  in the hospitality sector, running at up to 18%.