The larger than anticipated jump in UK inflation in April has prompted many to argue that the Bank of England’s Monetary Policy Committee will now be much slower to cut interest rates. But there is, of course, nothing that the MPC can do now about last month’s CPI.
The right question to ask is what the figures might be telling about the path of inflation in the future. The short answer is ‘not a lot’. Inflation is still set to fall back sharply over the one- to two-year horizon that really matters for monetary policy.
To recap, the headline CPI measure of inflation leapt from 2.6% in March to 3.5% in April. This was a little higher than the economist consensus of 3.3% (though in line with my own forecast).
Moreover, the broader CPIH measure (which includes a wider range of housing costs including council tax) was even higher, at 4.1%, and arguably better represents the experience of most households.
There were some global factors, notably the continued pass through of higher agricultural commodity prices. But the main drivers were Labour’s own policies on energy, employment costs, and tax, which have reopened the wedge between inflation in the UK and in the euro area.
The biggest contribution to the increase in inflation in April, as expected, was the jump in domestic utility bills, primarily energy but also with a large contribution from water. This is captured in ‘household services’ in the chart below.
This was followed by the continued pass through of higher payroll costs as a result of the measures announced in last October’s Budget. Rachel Reeves’ increases in the national minimum wage and in employers NI contributions have inevitably pushed up prices, as any serious economist would have predicted.
But the April figures were also distorted by the late timing of Easter, which boosted airfares and the cost of package holidays (reflected in transport and ‘recreation and culture’).
This temporary effect is one of several reasons why these figures should not overly worry the Bank of England. The Bank was already expecting inflation to climb to a peak at 3.7% in September and to average 3.5% in the third quarter, so the Easter distortion may just mean we are getting here a little sooner.
Global energy prices have also fallen back, and this should be reflected in the headline inflation data later in the year.
In the meantime, those fretting about a sustained ‘wage-price spiral’ seem to have missed the latest survey evidence, which suggests that underlying wage pressures are continuing to cool. In particular, pay settlements are typically coming in at or below 4%. The latest Brightmine and CIPD surveys actually suggest median increases of just 3%.
There is little in the monetary data to suggest that the jump in inflation will be sustained either. Broad money growth has picked up a bit from the lows in 2023 but is only running at around 4%. The ratio of broad money to nominal GDP also remains below its pre pandemic trend.
Crucially, all these figure are consistent with inflation returning to the target of 2% over the next year or so, assuming some recovery in productivity.
In short, today’s news should not prevent the Bank of England from continuing to cut interest rates gradually, from 4.25% to 3.5% early next year.
But this is little comfort now. The negative headlines and the renewed squeeze on real incomes will be a further blow to consumer and business confidence, and another reason to think that the strength of activity in the first quarter of the year was as good as it gets.
Plain-speaking Economics 