The tick up in UK CPI inflation to 4.0% in December last year was an unwelcome surprise, but one small miss in one month’s data does not change the big picture.
For a start, inflation is still lower than the Bank of England had been forecasting. The November Monetary Policy Report assumed that inflation would average 4.6% in 2023 Q4, but it was actually just under 4.2%. The Bank was also still expecting inflation to be 4.4% in 2024 Q1, and not return to the MPC’s 2% target until 2025 Q4.
The UK is also not alone in seeing inflation pick up in December (albeit for different reasons). One of the biggest jumps was in Germany, mainly due to adverse base effects in energy prices. Perhaps most strikingly, the UK now seems to be tracking France! This does not suggest that the UK (or ‘Brexit Britain’) has suddenly become an outlier on inflation again.
Of course, what matters now is where UK inflation is heading. Fortunately, a deeper dive into the factors that added to the headline rate in December is reassuring.
The largest positive contribution come from tobacco (mainly the duty hike in the Autumn Statement), which added 0.07 percentage points to CPI inflation. Crucially, this is a one-off. Duty rates are linked to RPI inflation (via an ‘escalator’), meaning future increases will be smaller.
Airfares chipped in 0.05pp, with another 0.04pp from ‘other recreational items, gardens and pets’ (including cat food, apparently!). These are erratic items and short-term moves here could soon be reversed.
Otherwise, both food inflation and core goods inflation remain on firm downward trends, with producer price data for both signalling that these components will fall away to zero in the coming months.
Energy inflation will plunge in April when the Ofgem cap on domestic bills is reduced (this is now nailed on, given the falls in the prices of wholesale gas.)
This leaves services inflation, which edged up from 6.3% to 6.4%. The hawks on the MPC might see this as justifying their fears about a ‘wage-price spiral’. But this matters much less if other components of inflation are set to fall more sharply. In the meantime, the labour market continues to cool, and growth in both the money supply and credit are still weak.
My prediction is that inflation will still be around 4% in January, hopefully a little lower, but the annual rate should then drop rapidly again, hitting 2% in April.
What does this all mean for monetary policy? There is now no realistic chance of a rate cut in February (always unlikely), though the forecasts in next month’s Monetary Policy Report (MPR) should be more dovish than in November.
The late March meeting is still a possibility, with two more sets of monthly data to come, and time to digest the Spring Budget. But a first cut in May now looks most likely, supported by a new MPR.
There will be six MPC meetings between May and December, leaving plenty of time for the Bank to cut rates from the current 5.25% to around 4% by the end of the year. Fingers crossed.
What could go wrong? I see three main risks. One is new supply shocks – notably the Red Sea crisis and the additional post-Brexit checks on imports from the EU. But as I discussed in an earlier blog here, these are unlikely to blow inflation off course.
A second risk is that services inflation is kept higher for longer by rising wages. The near-10% hike in the National Living Wage in April will not help here. However, most surveys suggest that private sector pay settlements will fall to around 4-5% this year, and recruiters are reporting that labour is no longer in such short supply.
The third is fiscal policy. Will the Chancellor go mad in the March Budget (or at least, that is how some on the MPC might see it) and slash taxes? But I am not expecting anything that would dramatically shift the dial on inflation or (more’s the pity) economic growth.
Plain-speaking Economics 
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