UK: THE INFLATION HUMP IS NOT OVER YET

The surprise dip in UK inflation in July is likely to be a one-off. It is not the first sign of easing inflationary pressures in the UK, in our view. The headline rate of consumer prices slowed to 2.0% yoy in July from 2.5% in June – Chart 1. Core inflation eased from 2.5% to 1.8% in July with both services and goods inflation edging lower - Chart 2.

Big surge coming in August as base effects are reversed

Oscillating virus restrictions since March 2020 distort price setting behaviour and complicate statistical measures. Together, such factors create an unusual amount of volatility in yoy inflation. In the July annual measures, this effect is amplified by items that became available in July 2020 at the end of the first lockdown at somewhat elevated prices as well as the return to a more normal pattern of summer sales this year.

The ONS notes that ‘collected prices in July 2020 had an upward effect on the index between June and July 2020, and consequently a downward effect on the change in the 12-month rate between June and July 2021’.

The headline consumer price index was unchanged mom in July 2021 following average monthly gains of 0.5% between March and June. Part of the mom slowdown is simply due to summer sales in retail – clothing and footwear prices declined 2.0% mom after falling a mere 0.7% in July last year. The big drop in the annual rate this July stems largely from the volatility and base effects linked to monthly changes in 2020. Consumer prices jumped by 0.5% mom in July 2020, lifting the yoy rate from 0.6% in June 2020 to 1.0% in July 2020. This had a large downward effect on the yoy rate in July 2021.

The quirk will likely reverse in August 2021 - prices declined by 0.5% mom in August 2020, offsetting the gain of the previous month. If consumer prices remain unchanged (which is unlikely) between July and August, the yoy rate will rise to 2.5%. More likely in our view, the intensifying cost pressures for producers and distributors and the end of sales will raise prices in August by at least 0.5% mom, in line with the March-June average (0.5% mom). That would raise the headline yoy rate to at least 3%.

Underlying price pressures continue to build

Significant further price pressures coming from rising labour costs (amid record labour demand) and surging input prices will likely push consumer price inflation to well above the BoE’s 2% target in the coming months – Chart 3. Producer input prices jumped by 0.8% mom in July following a 0.5% gain in June – this pushed the yoy rate to 9.9% from 9.7%. The mom change in input prices was stable at 0.6% in July – lifting the yoy rate to 4.9% from 4.5%.

Cost push price inflation could intensify in the coming months. Producers continue to suffer severe supply chain issues caused by shortages of commodities, key inputs (e.g. semiconductors) as well as labour, while dislocations and delays at ports have apparently worsened in recent weeks. Amid strong domestic demand and significant pricing power, firms will try to pass on cost rises to consumers.

Inflation outlook

In the BoE’s August projection, the bank projected 4.0% yoy consumer price inflation in Q4 – following significant upward revisions from previous forecast rounds (Chart 4). While we project a somewhat smaller surge – with a 3.7% peak in Q1 2021, the unusual volatility in the yoy rate of inflation in the wake of special factors related to the pandemic suggest caution in placing too much weight on precise projections. Amid surging input and wage costs, underlying forces of demand and supply point to significant and sustained inflation over the duration of the coming business cycle.

Kallum Pickering
Senior Economist, Director

Mobile +44 791 710 6575

Phone +44 203 465 2672

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