Chart of the Week: UK inflation proving sticky

In Fathom Consulting’s Global Outlook, Spring 2023, finalised early last month, we had more concerns about inflation persistence in the UK than in either Europe or the US. Although our central forecast saw UK inflation falling sharply throughout this year, and dropping below the 2% target early next year, there were two main risks to this outlook. Both risks would cause inflation to be higher than in our central forecast: either because the UK avoided recession and the economy continued to operate above potential for longer, or because enduring second-round effects from the initial price spike caused higher inflation to become embedded. The UK CPI figures for March suggests that this second risk may be materialising. Headline CPI surprised on the upside at 10.1% rather the Reuters Poll consensus of 9.8%, driven by rises in the costs of food, and recreation and culture. But the more concerning trend lies in stubbornly high rates of core inflation. Core inflation, which excludes energy, food, alcohol and tobacco, remained unchanged at 6.2%, when the consensus had been for a fall to 6.0%. This is fuelled by wage increases that are not consistent with meeting the 2% inflation target —data released on 18 April showed that annual private sector wage growth was up 6.9% year on year in the three months to February: a fall from 7.3% in the fourth quarter of 2022, but a smaller than expected drop. This combination of persistently high core inflation, and private sector wage increases that are far from consistent with the 2% inflation target, suggests that enduring second-round effects may indeed have caused inflation to become embedded. Expectations of future interest rate rises have strengthened, as the Bank of England tries to cool the economy. Financial markets are now pricing in a 25bp raise in May, followed by further increases which are likely to leave us at a bank rate of 5% at the end of the year.

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