August inflation was as flat as one of those cakes from a pan, but don’t be lulled into a false sense of security, fireworks are ahead.
UK inflation stood at 0.6% in August, as it did the month before. It has been on the rise this year, but only very slowly and much more slowly than expected a few months ago. Back in January, UK inflation was 0.3%, so that’s a rise of just 0.3 percentage points in just over half a year.
But there are reasons to expect it to rise.
For one thing, you need to bear in mind that the annual inflation rate is made up of 12 month-on-month inflation rates. This means that what happened a year ago matters. In September 2015 month on month inflation was minus 0.1%. So for the annual rate to rise this month, prices need only stay still in September compared to August. Given the recent falls in sterling, if we don’t see an increase in inflation when the data is released in a months’ time, it will be a big surprise.
In October, November and December 2015, month on month inflation was 0.1%, zero and 0.1%, in that order. So you would expect inflation to carry on edging up for the remainder of this year.
But in January 2016, month on month inflation was minus 0.8%. Now as it happens, January often sees low inflation, but by January next year, the falls in the pound really should be hitting prices. UK inflation will surely shoot up in early 2017.
Some economists, the likes of Scott Bowman, UK Economist at Capital Economics, for example, reckon that UK inflation will hit 2% by the middle of next year, and 3% by the year’s end. Samuel Tombs at Pantheon Macroeconomics reckons UK inflation will hit 2% as soon as February, and average 3% in the second half of 2017.
So what are the implications of that?
At some point next year, inflation will probably be rising faster than wages – that won’t go down well, and will surely hit consumer spending.
But the Bank of England probably won’t react by upping interest rates, because when it monitors inflation what is supposed to matter is core inflation. The bank is also meant to ignore price changes caused by swings in the commodity cycle, or the fortunes of the pound. Core inflation – that’s without food and energy – has not risen so far, and stands at 1.3%, and has been pretty static all year, it was 1.2% in January for example, but 1.3% in December last year. But even core inflation will be distorted by the recent falls in sterling.
In a nutshell, the commodity cycle has hit bottom and may be on a slow move back upwards, that will push on inflation. For Brexit related reasons, the pound fell, and that too will exert pressure on inflation. As a result, inflation may pass 3% next year, hitting real wages and consumption, but rates are likely to stay firm, or even fall. In the medium term – say two or three years – headline inflation should be close to core inflation and right now that is modest.