UK Inflation Hits 30-month High

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UK consumer price inflation rose by more than expected to 1.6% in December, from 1.2% in November. Consensus forecasts had pointed to a smaller increase to 1.4%. This is the highest rate since July 2014.

The market reaction to the figures was muted, with both the FTSE and the pound largely unaffected.

The main contributors to the acceleration in inflation were motor fuels, air fares, food and clothing – all of which have been affected by the weak pound. Food producers have faced sharply rising input costs, while oil is of course priced in dollars.

More inflation to come, in the short term at least…

December’s producer price data contains a strong indicator that higher inflation is coming. Input costs rose 15.8% year-on-year – the highest figure recorded for more than five years. It’s unlikely cost increases of this magnitude can be fully absorbed by firms, leaving them with little choice but to pass some on to consumers in the coming months.

The Bank of England says CPI inflation will exceed the 2% target by the middle of the year, though I wouldn’t be surprised if it happens sooner than that. Mark Carney also says the resulting squeeze on household budgets will cause the economy to slow as we move through 2017.

…but longer-term inflation should remain structurally low

However, the effect of the weak pound, assuming it doesn’t fall much further, is a one-off factor which will fall out of the figures eventually. The longer-term picture is one of structurally low inflation – due in part to demographic reasons. The baby boomers are starting to retire and have already gone thorough their consumption phase – they have bought their houses, cars and consumer goods. The younger generation is saddled with debt and struggling to get on the housing ladder. Workers don’t have the bargaining power over pay they once did, and wage growth looks set to be anaemic at best.

All this should mean less inflationary pressure and relatively lacklustre economic growth. Assuming the Bank of England is prepared to ‘look through’ what looks like a temporary spike in inflation, this should mean interest rates remain at rock bottom for the foreseeable future.

Authored by Ben Brettell, Senior Economist, Hargreaves Lansdown.

(Source: Hargreaves Lansdown)

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