UK Inflation: Love It Or Hate It, It’s Not Going Away

Tom Traill - 19th October 2016

The UK referendum result has sent a series of shock waves through the currency markets that leaves Sterling 16% weaker on an index basis, 18% weaker against the US Dollar and 15% weaker versus the Euro. It is fanciful to suppose that currency effects of this magnitude can somehow be absorbed in producers’ or distributors’ cost structures. Consumer price inflation is about to soar as a direct consequence of Brexit.  

At Economic Perspectives, we have expected the return of inflation for some while, not only in the UK but also in a cluster of developed economies. We examined the issues recently in our quarterly Global Inflation Perspective publication, and recently wrote a blog about UK inflation that was featured in Money Week magazine.

The fall in Sterling has fed through rapidly into producer prices: producer input prices are up 7.2% in September, when they had been falling only three months previously. Producer output prices had been falling for two years by June this year, but in the recent data annual inflation was over one percent. UK import prices are also rising strongly, after falling from the summer of 2012 until May of 2016 they are now rising at 6.5%pa. These are big changes, and, as the chart shows, they are all closely linked to the weakness of Sterling. Very little of this pipeline of inflation pressures has reached the consumer.

A prominent headline last week offered an insight into UK inflationary pressures. Unilever and Tesco were in discussions over the UK pricing of their products, such as Marmite. Tesco spun the story to try and show itself as a consumer champion, but the reality is that neither Unilever or Tesco could afford to absorb these cost increases: the inflationary pressures are real.

Sterling may now be undervalued, but while it remains below its previous, pre-referendum, level there will be continued upward pressure on prices. This is not hypothetical, there is a continued drift towards inflation normalisation and this new weak-currency environment is another contributing factor. There are indications that food and commodities prices might be bottoming out just as the oil price plunge unwinds, removing influences that have helped subdue headline inflation.

Furthermore, policy makers have an incentive to allow an increase in inflation. Bank of England governor Mark Carney has said that they will tolerate an inflation overshoot, and one imagines that Chancellor of the Exchequer Philip Hammond would not lose sleep over the government’s debt burden being eroded in real terms. Brexit has rocked the inflationary boat: the headline CPI is next.
 


 


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