Has inflation finally peaked?

At long last, UK inflation appears to have peaked.

After hitting a 41-year high of 11.1% in October, the annual rate of consumer price inflation dropped to 10.7% in November — a bigger fall than the 10.9% predicted by economists. 

While the Bank of England doesn’t expect inflation to return to its 2% target until early 2024, the general consensus is that the worst of the price surge is finally behind us.

Equally reassuring is that the same pattern is emerging elsewhere: both the US and eurozone reported larger than expected drops in consumer prices for November. 

The pound has also reached six-month highs against the dollar. Sterling’s recovery is good news as it stops Britain importing inflation – buying goods from abroad will be cheaper. 

Yet tricky times still lie ahead. The benefits of passing the peak are unlikely to filter down to households in the short term, meaning the cost of living will continue to squeeze the UK economy through 2023.

The breakdown of inflation components in today’s figures also offers mixed signals on just how fast inflation is likely to fall.

Motor fuels have fallen especially sharply thanks to plummeting global oil prices. And Core CPI – which excludes energy, food, alcohol and tobacco prices and is often thought to better reflect longer-term price trends – firmly dropped to 6.3% in November from 6.5% in October.

Yet pockets of resistance in the price dynamics remain. Notably, services inflation continues to buck the trend. Services sector inflation – which some economists and officials think reflects wage pressures being passed on by companies – held at October’s 30-year high of 6.3%.

This new data will relieve the Bank of England’s Monetary Policy Committee as it prepares to meet tomorrow to discuss the next interest rate hike. But it could make reaching a decision that bit harder. 

In November, the MPC finally took the plunge already taken by US and European central banks and made a three-quarter-point rate rise – its biggest in over 30 years.

Today’s softer-than-expected figures could persuade the committee to slow down the pace. Most economists forecast that the MPC will raise rates from 3% to 3.5%. The hawkish Fed is also predicted to make a more modest 50bps rate hike this evening. 

Yet we are likely to see a split vote in the UK, with Bank of England policymakers increasingly divided on the right response. 

Some may lean towards a more modest hike – mindful of the Bank’s own forecasts that the UK economy is heading into a long recession. They will be wary too of inflicting further pain on those with mortgages. Just yesterday, the Bank published a report estimating that four million households in Britain are already set to face a £250 monthly mortgage rise next year.

On the other hand, slowing rate hikes too drastically could cause the pound to weaken again. And Bank of England officials are divided on just how much of the impact of past rate rises is yet to be felt. 

The prospect of secondary inflation setting in is still a major consideration. Businesses, for instance, may still raise prices in delayed reaction to rising costs. And Britain’s industrial action could throw in a curveball too. If the government bows to union demands and raises public pay substantially, then a wage price spiral could ensue.

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