Inflation finally dips
UK inflation has dipped below double digits, the first decline in almost a year, largely thanks to falling fuel prices.
The headline consumer price index had been forecast to rise to 10.2% in August. But forecasts were overly gloomy. Instead, it dropped from its 40 year high in July of 10.1% to 9.9%. The easing reflects some respite at the petrol pumps: A litre of petrol fell from an average price of £1.90 in July to £1.75 during the month, as the cost of oil has been on a downwards trajectory.
That said, Britain’s inflation rate was still among the highest in the G7 in August although lower than both Spain and the Netherlands. The cost of food and domestic services shows no sign of easing. As the war in Ukraine continues to disrupt supply chains, food prices last month rose at their fastest pace since 2008, up 13.4% in August, compared to 12.8% in July. The cost of domestic services rose 5.9% higher in August, up from 5.7% in July, thanks to the UK’s tight labour market, made worse by the exodus of workers during the pandemic.
So how significant is the drop from double digits? Could it mean inflation has peaked?
It’s unlikely. Most economists reckon inflation will creep up again.
But there is some good news: when we do reach the peak, it will likely be much closer to where we are now at around 11%. Previously, inflation was forecast to surge to over 15% with some economists predicting 18%.
These revised forecasts are thanks to Truss’s energy package.
Her £150bn plan to freeze the typical annual household bill at £2,500 – to protect consumers from huge energy price rises in October – is expected to take between 4 to 6 percentage points off headline inflation in the coming months. At the same time, the future prices of natural gas are beginning to fall as are shipping rates around the world.
Why then is inflation still expected to creep up again?
Firstly, because food and domestic services may rise again, offsetting falling fuel prices. What’s more, despite the confirmed freeze, the average household energy bill will still rise in October by about 25% from its current level. This alone, according to Capital Economics, will add about 0.7 percentage points to inflation.
Another potential inflationary pressure is that the government’s energy package and prospective tax cuts will bring an increase in consumer spending power.
Rather than now being on a downwards trajectory, the UK is likely to experience something similar to the inflation yo-yoing which has occurred across the Atlantic in recent months. On Tuesday, the headline rate of inflation in the US unexpectedly rose by 0.1%.
This means the Bank of England will continue to raise interest rates repeatedly in the coming months: from its current level of 1.75% to at least 3% by the end of the year.
But when the Monetary Policy Committee does meet next Thursday, its members may well go for a softer 0.5 percentage point increase rather than the aggressive 0.75 bp hike that some had been predicting.
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