Working out why inflation is falling is not so hard. After the EU referendum, sterling fell sharply. A drop in the pound always leads to a rise in prices, but with time lags.
The sterling falls occurred in the spring of 2016, the inflation effect seemed to peak in the winter of 2017.
There are reasons to think that inflation will fall this year, and indeed next. As the one off-effect of the post Brexit fall in sterling eases its way out of the system, inflation should fall sharply – maybe head back down to two per cent, or lower – after-all, in the euro area, core inflation (with good and energy taken out) is less than one per cent. In theory, after currency differences, the two inflation rates should converge.
But in recent weeks, the pound has been rising, especially against the dollar, furthermore, a number of analysts expect it to carry on rising.
The pound is still below the post Brexit vote level – $1.50 dollars in June 2016, $1.35 at time of writing, and 1.3 euros in June 2015 versus 1.125 euros or so at time of writing. But then at one point after the referendum, sterling was down to $1.22 and 1.08 euros.
It will take time for any rises we see in the pound to show up in the inflation data, but if the analysts are right, and sterling does rise this year, UK inflation should dip towards the end of next year.
At least that would have been the case if it wasn’t for the oil price. This has been steadily rising, and is expected to rise this year – Brent crude oil has risen from less than $50 a barrel a year ago, to $70, as of this week.
The rises in the oil price may give inflation another lift, this year.
So, it seems, we have two contradictory forces at play,
Samuel Tombs at Pantheon Macroeconomics said: “The continued weakness of underlying price pressures means that the [Bank of England rate setting committee] MPC has little need to rush the next rate hike.”
Paul Hollingsworth, Senior UK Economist at Capital Economics said: "The MPC is unlikely to feel pressured into raising rates again very soon. Indeed, barring a big pick-up in wage growth in next week’s labour market figures, there is little in the latest economic data to justify another rate hike at the MPC’s next meeting on 8th February. But if we are right in thinking that the economy holds up better than most expect, and that wage growth does build over the coming months, then we think the next hike could come around May, much earlier than markets expect.”