(Written on 2 May)
Ouch! It looks increasingly likely that the headline measure of consumer price inflation is going to start with a ‘9’ in April (official data will be released on 18 May).
Most economists had expected a jump from 7pc in March to around 8.5pc. This assumed that the price increases we already know about – notably the 54pc hike in the Ofgem cap on domestic energy bills – would be at least partly offset by slower inflation elsewhere.
Unfortunately, this doesn’t appear to have happened. In particular, petrol and diesel prices have edged up further, despite the 5p cut in fuel duty, and food price inflation is continuing to rise. These pressures have been compounded by the geopolitical risks that Liam Halligan explained well in the Sunday Telegraph.
I have therefore upped my own forecast to 9pc for consumer price index (CPI) inflation in April, with the alternative RPI measure well into double figures, at 11pc. Both could be even higher. There are three main takeaways.
First, these numbers would (yet again) be well above the official projections used by policy-makers, adding to worries about the impact of higher inflation on real incomes and debt interest costs.
The forecasts prepared for the Spring Statement assumed that CPI inflation would average 7.7pc between April and June. And at its last rate-setting meeting in March, the Bank of England Monetary Policy Committee (MPC) was only expecting inflation of ‘around 8pc’ in April.
Indeed, assuming Bank staff are doing the same maths as me, the continued overshoot of inflation could make a half point hike in interest rates more likely when the MPC’s latest decision is announced on Thursday. The markets only expect a quarter point increase, but there is a strong case for a bolder move.
Second, many will fear that UK inflation will rise even further in October when the Ofgem cap is next due to change. Forecasts that CPI inflation will still be 10pc or more at the end of the year will be increasingly common.
For now, I still expect April to be the peak. But this relies on some optimistic assumptions about geopolitical risks and global energy prices, and on better policy choices by both the government and the central bank.
Third, UK inflation is about to climb above the EU average (the first estimate for the euro area in April was 7.5pc). The usual suspects will inevitably blame this on Brexit.
There have already been many strong claims in the last few days, including that Brexit explains 80pc of the UK’s inflation problem, and that has it added 6pc to UK food prices.
Let’s unpick some of this. Brexit has probably added to cost and price pressures in several ways, including the disruption to international trade and supply chains, additional labour shortages, and lower business investment. Nonetheless, there is little evidence of any significant impact on inflation itself.
UK consumer price inflation has not deviated far from the average in the euro area, and for most of the last year it has actually been lower. Assuming this changed in April, the main factor is not Brexit, but government policy on energy prices.
The UK government is allowing more of the increase in wholesale energy costs to feed through to final prices (like in Belgium, where consumer price inflation was 9.3pc in April, or the Netherlands, at 11.2pc).
This contrasts with countries which have intervened more aggressively to keep prices down (notably France, at 5.4pc). Instead, the UK has focused on providing more support via the tax and benefit system.
Some academic studies have attempted to isolate the effects of Brexit on inflation in specific sectors. For example, research published last week by ‘UK in a Changing Europe’ has suggested that the increase in UK-EU trade barriers led to a 6pc increase in food prices in the UK between the end of 2019 and September 2021.
However, this is hard to square with the actual data, which also show that UK food price inflation has remained relatively low. It is possible that the gap in favour of the UK would have been even bigger without Brexit (this has been a period of sterling strength against the euro, which will have kept import prices down), but a 6pc premium is still a big stretch.
Research in this area has become increasingly dependent on complex methods and models. Sometime it pays just to step back and look at the underlying data to gauge the plausibility of the results. These appear to fail the ‘sniff test’.
Some of the commentary here also relies heavily on predictions, instead of hard facts. In particular, the US economist and former MPC member, Adam Posen, has been widely reported as saying that Brexit is ‘80pc of the reason’ for the UK’s inflation problem.
Clearly this makes no sense at all if applied to the current rates of inflation. But Posen was actually referring to IMF forecasts for 2023, when the UK is expected to see the highest inflation in the G7 next year.
This is just speculation. Citing IMF projections as evidence here is also circular: the IMF expects UK inflation to remain high because of Brexit and so this is what it is forecasting. But it has been spectacularly wrong on the UK economy for many years.
In short, it is plausible that the departure from the EU has added at least a little to the upward pressures on UK prices. This underlines the importance of efforts to ease trade frictions, reduce uncertainty, and exploit new Brexit opportunities to offset these additional costs. However, any Brexit impact on inflation has been dwarfed by other factors – and this is likely to continue.
This piece was first published in the Daily Telegraph on 3 May 2022
Post script (7 May) Since this piece was written the Bank of England has raised its own forecast for CPI inflation in April to 9.1%. Despite this, only three of the nine members of the MPC voted for a half point hike in interest rates.
The Bank also noted that the main reason why inflation is expected to peak later in the UK than in many other countries, and may therefore fall back later, is the operation of the Ofgem cap (and is not, as some have suggested, 80% due to Brexit).
I would add that the Bank’s projection that UK CPI inflation will average more than 10% in Q4 2022 is based on assumptions that are almost certainly wrong. Like other official forecasters (including the OBR and IMF), the Bank bases its estimates on current government policy (rather than what is actually likely to happen, especially on the Ofgem cap) and on market expectations for interest rates and energy prices (which are probably too high).