It all looked so easy. When Rishi Sunak pledged to halve inflation this year most commentators thought that this was already locked in. The base for comparison was inflated and many prices were near their cyclical peaks – indeed energy prices had already fallen sharply and this was due to be reflected in consumer prices.
The government’s official forecaster, the Office for Budget Responsibility, as recently as March predicted an average rate of inflation of 6.3% for the calendar year of 2023 falling to 0.9% in 2024.
And yet we are now half way through the year and although CPI inflation has at least fallen back to single figures, 8.7% on today’s data, core inflation is still rising. Today’s data shows it has risen to 7.1% compared with 5.8% in France and Germany and 5.3% in the US.
Of the G20 countries only Argentina, Turkey, Brazil and Mexico have higher core inflation.
The persistence of core inflation and the increase in wage inflation (now running at 7.2%) suggests that inflation is likely to provide more persistent than the OBR (and to be fair, my own colleagues at Cebr, though we have been consistently less wrong than the OBR) had predicted.
Many monetarists have drawn attention to the persistence of high inflation as evidence that the Bank of England has paid far too little attention to monetary influences (unlike in Germany and Switzerland no monetarist has ever been appointed to the MPC in the UK).
It is certainly true that the proximate cause of high inflation was the monetary free for all during the pandemic.
But the data suggesting that inflation may be much more persistent than had been expected is a challenge to monetarists as well as the more Keynesian economists. Monetarists have been warning of monetary overkill for some time and the chart above, with monetary growth below 2% in Q4 last year, shows why.
But if inflation remains near to its core rate for the next 6 months, even the monetarists, who have had a good run recently, will be forced to eat their words.
The problem with UK inflation is the same as we found in the 1970s. Once it gets entrenched into expectations it cannot be removed painlessly. The processes of raising inflation and reducing it are asymmetric. This is why sensible monetary authorities err on the side of low inflation – if inflationary expectations get out of control the scale of economic damage that is required to bring them back under control is disproportionate.
The government should also look at supply side policies to reduce inflationary pressure. UK energy policy has been a mess for a long time and as a result electricity prices are amongst the highest in the G7. Food prices have not yet reflected the Brexit freedom to buy cheap food abroad. Severe planning restrictions, restrictions on buy to let and now fire restrictions introduced post Grenfell Tower are adding to the cost of housing.
None of these will solve the short term problem but at least they might help in the coming years.
Douglas McWilliams is Deputy Chairman of Cebr
