As inflation hits its highest level since June 2014, rising import costs triggered by the weak pound will heap more pressure on consumers, writes Gareth Mackie.
The consumer prices index (CPI) measure of inflation is edging closer to the Bank of England’s 2 per cent target, and many observers, including those at the central bank itself, expect that level to be breached soon.
By the end of this year, inflation is likely to be around 3 per cent and possibly even higherAndrew Sentance
With sterling taking a hammering in the wake of the Brexit vote, factories have seen their costs spiral, with official data showing that input prices soared by 20.5 per cent in January – the fastest rate of growth since September 2008.
Mike Prestwood, head of inflation at the Office for National Statistics (ONS), says the rise in CPI to 1.8 per cent – up from 1.6 per cent in December – was triggered by rising petrol and diesel prices and a “significant slowdown in the fall in food prices”.
Although the CPI reading came in shy of economists’ expectations of 1.9 per cent, it is now at a two-and-a-half-year high and poised to continue climbing.
Howard Archer, chief UK and European economist at IHS Global Insight, says the recent strengthening of oil and commodity prices is piling added pressure on manufacturers to lift their prices, which could see inflation break through the 2 per cent level this month, before rising to 3 per cent towards the end of this year and peaking at about 3.3 per cent early in 2018.
That would be some way above the Bank of England’s forecasts. In its most recent inflation report, the Bank said CPI is expected to increase to 2.8 per cent in the first half of 2018, and then fall back gradually to 2.4 per cent in three years’ time.
CBI chief economist Rain Newton-Smith says firms are feeling the impact of the low pound, adding that it was “crucial” for the UK government not to add to their woes in the upcoming Budget, due on 8 March.
In the organisation’s recent Budget submission to Chancellor Philip Hammond, Newton-Smith said: “While the economy has proved resilient, inflation is rising and growth is set to slow. As uncertainty around the manner of our EU exit dampens investment and higher inflation erodes consumer spending growth, the government must show that it is serious about supporting companies to invest, to help our regions and nations prosper.”
But the government has no control over borrowing costs, which are set by the Bank of England’s monetary policy committee (MPC), and Archer believes that rate-setters are prepared to sit on their hands and keep interest rates at their current record low of 0.25 per cent for some time to come.
“While the Bank of England is clearly getting twitchier over the UK inflation outlook, we suspect it will end up sitting tight on interest rates through 2017 and 2018 at least,” he says.
Low interest rates may be welcomed by borrowers, but the news isn’t so good for those trying to grow their savings balances amid weak wages growth.
Calum Bennie, savings expert at Scottish Friendly, says: “The greatest struggle is for savers who continue to suffer as there seems little prospect of a rise in interest rates in the near future. People looking to put money aside for several years might consider investment ISAs as an alternative to get better long-term growth potential.”
Overall food prices were flat between December and January after falling 0.6 per cent a year ago, as the sharp drop in grocery costs, triggered in part by the supermarket price war, ground to a halt. The ONS said a rise in the cost of imported foods caused by the Brexit-hit pound may have been a factor that caused the fall in food prices to slow.
The Treasury argues that it has cut taxes and frozen fuel duty to help families concerned about the cost of living, but Nancy Curtin, chief investment officer at Close Brothers Asset Management, says rising prices will hit consumers’ wallets, “particularly given the fact wage growth just isn’t keeping up”, and the MPC may wait until after Prime Minister Theresa May has triggered Article 50 to begin the formal Brexit process and “business intentions are known” before making a move on borrowing costs.
Kristin Forbes, one of the nine members of the MPC, signalled last week that she was inching closer to voting for a rate rise after becoming increasingly “uncomfortable” with surging inflation given the economy’s resilience to the Brexit vote.
Despite rising inflation putting a further squeeze on consumer spending, Andrew Sentance, senior economic adviser at PwC, expects UK economic growth to hit around 1.5 per cent for both this year and next.
He adds: “The trend is clearly towards higher inflation, however, and we should expect the rate of price increases to rise above the 2 per cent Bank of England target in the next few months. By the end of this year, inflation is likely to be around 3 per cent and possibly even higher.”