Inflation may have peaked – but families still face months more pain
14th December 2022
The worst may be over, but income squeeze is likely to drag on well into 2023
The rise in the cost of living has been relentless. Consumers have been spending more to buy less on almost everything this year. But there are finally signs that UK inflation has peaked.
Price rises eased back from their 41-year high in November as motorists suffered slower increases in petrol and diesel costs.
Prices, as measured by the consumer prices index (CPI), were 10.7pc higher last month than a year earlier. This is down from 11.1pc in October and below analysts’ expectations for a decline to 10.9pc.
City economists believe the UK has passed the peak of inflation – but how quickly and how far price growth will come down is still hotly debated, not least at the Bank of England.
The faster-than-expected fall raises hopes that the Bank will not have to increase interest rates from 3pc to the 4.5pc currently expected by investors in order to keep a lid on price rises.
However, inflation still remains well above the Bank’s 2pc target, and economists believe it will stay in double digits well into next year.
A lot of this is likely to be driven by stubbornly high supermarket prices. Food and drink costs jumped by 16.4pc in the year to November, while the Office for National Statistics (ONS) warned that price rises were becoming increasingly widespread.
Dairy and egg prices have posted some of the biggest increases over the past year. The average price of a dozen eggs has increased by 50p since the spring to £2.99, while a pint of milk has climbed from 45p to 67p, and 500g of spreadable butter has gone up from £3.28 to £4.21, according to the ONS.
Meat and fish prices are also up sharply. A kilo of salmon fillets now costs almost £19, compared with £14.20 in November 2021.
Economists have highlighted just how stubborn inflation is in the UK compared with other major advanced economies.
OECD analysis shows more than half of the goods and services used to calculate Britain’s inflation rate are rising at an annual pace of 6pc or more. This is higher than any other G7 nation.
Analysts expect food prices to keep rising in the run-up to Christmas as growing transport and packaging costs make imports more expensive.
Division over inflation has thrown up the prospect of a four-way split on the Bank’s nine-strong Monetary Policy Committee for the first time ever when it meets on Thursday to consider increasing interest rates from their current level of 3pc.
At the dovish end, rate-setter Silvana Tenreyro may vote to pause tightening now. Hawks like deputy governor Sir Dave Ramsden, could back another big rise.
Simon French, chief economist at Panmure Gordon, says a split reflects the “divergence of views even amongst very informed individuals as to what the right prescription is right now”.
He says market expectations for another 1.5 percentage points of rate increases are more than the Bank is likely to deliver.
The rate-setters have voted for an increase at every meeting this year, including the unusually high 0.75 percentage point rise announced last month.
But a falling inflation rate will allow the Bank to ease off the accelerator quickly, offering relief for millions of mortgage holders and the Chancellor Jeremy Hunt.
Markets are betting that the Bank will vote for a 0.5 percentage point increase in rates on Thursday, taking them to 3.5pc, before it eventually stops at 4.5pc in mid-2023. City forecasters expect a halt even sooner.
Philip Shaw, an economist at Investec, says: “We’re not at the point where the Monetary Policy Committee can sit back and say, ‘We’ve done enough for now’.”
He expects two more increases to take Bank rate to 4pc, but says that from then “what starts off as being a pause ends up being the end of the cycle” in rate rises.
“We’re actually looking towards interest rate reductions towards the end of next year,” Shaw adds.
The ONS itself is cautious about calling the peak in price rises. Grant Fitzner, its chief economist, says that while inflation has surged because of soaring power bills driven by Russia’s invasion of Ukraine, price rises are “no longer just an energy story” and have instead become widespread among goods and services.
He told the BBC: “Some may be calling this a peak. I think it’s too early. We’ve only seen one fall from a 40-year high. Let’s wait a few months and see how it goes.”
Mr Hunt also suggested that giving in to public sector demands for above-inflation pay rises could fuel inflation further.
“I know it is tough for many right now, but it is vital that we take the tough decisions needed to tackle inflation – the number one enemy that makes everyone poorer,” he said.
“If we make the wrong choices now, high prices will persist and prolong the pain for millions.”
As the Chancellor highlighted, where inflation goes next is important for pay deals across the economy. Most of them are negotiated by April.
A sharp fall in inflation and climbing unemployment could take the heat out of wage demands. But wage growth might instead be kept high by a continued tightness in the labour market after so many workers dropped out altogether to retire early or because of long-term sickness.
Allan Monks, an economist at JPMorgan, warns that consumers should expect persistent inflation. He says: “It’s hard to see core inflation sustaining a return to target while wage growth is running so strong at over 6pc. Some surveys hint at a moderation, but others don’t.
“With energy bills set to rise next April, inflation is still set to stay well above target in 2023.”
Others aren’t so sure. Kallum Pickering, economist at Berenberg, says it is “not unreasonable to think that we’re going to be quite close to 2pc by this time next year”. He expects less pressure on the headline rate from energy and food prices, as well as lower domestically generated inflation including from wages.
“Tight financial conditions and the recession should do away with at least some of that domestically generated inflation,” Pickering says.
“When you look forward six to 12 months, you say, ‘well, all the base effects from the high energy prices and food are going to be washed out, and then you’re going to have the cumulative effect of the recession and the tight financial conditions’.”
The retail prices index (RPI), which is not an official statistic but is still used to calculate increases in rail fares, mobile phone tariffs and around a quarter of the UK’s debt pile, rose at an annual pace of 14pc in November. Core inflation, which strips out volatile food and energy costs, was 6.3pc.
The Bank of England’s decision on Thursday will shed some light on where it believes inflation is going next. Kitty Ussher, chief economist at the Institute of Directors, describes the bigger-than-expected drop in the headline rate as “encouraging news, giving hope that the UK, like the US, may soon be through the worst of the inflationary peak.”
However, she adds: “On balance we still think the Bank should continue to raise rates, albeit slightly, until the downward path of inflation is firmly entrenched in business expectations.”
Authors: Szu Ping Chan and Tom Rees
Managing Director, Head of Research