UK Inflation Slowed, Sped and Disappointed

Wednesday, the Office for National Statistics (ONS) published its widely watched Consumer Price Index (CPI, a government-produced index tracking prices of commonly consumed goods and services)—which has been front and centre for many observers we follow for nearly two years. And in April, that seemingly continued, as headline inflation slowed—but not as much as publications we read anticipated—and core inflation actually accelerated.^[i] Predictably, we saw the data lead to many forecasts from commentators we follow of further Bank of England rate hikes to come, calls for more government action to rein prices in—and a general deepening in investor malaise. These data aren’t terribly pretty, but in our view, whilst it may take time to develop, we think there is ample room for positive surprise on UK prices from here.

April’s headline CPI slowed bigtime—from 10.1% y/y in March to 8.7% in April, -2.4 percentage points below October 2022’s peak.^[ii] But this seemingly big positive was muted by the fact almost every observer we follow knew a sharp improvement was coming—largely tied to energy prices. The government, of course, caps household energy prices. Last year, it ratcheted those caps up bigtime, as energy prices rose—but with energy prices falling, that didn’t repeat.^[iii] As energy prices swiftly declined globally, the year-over-year household energy inflation rate in the UK slowed dramatically (from 85.6% y/y in March to 24.3% in April).^[iv]

Furthermore, even last month’s big CPI slowing missed observers’ forecasts. Analysts had anticipated prices to decelerate to 8.2% y/y in April.^[v] Just a couple weeks ago the Bank of England (BoE) said it anticipated 8.4%.^[vi] Why the miss? Many analysts noted food prices remain hot, rising 19.0% y/y, a microscopic slowdown from 19.1% in March.^[vii] But even beyond this, core prices—which exclude food, energy, alcohol and tobacco—actually accelerated from 6.2% y/y to 6.8%, as services prices jumped, registering the hottest rate since March 1992.^[viii] On a month-over-month basis, UK prices rose by a quick 1.2% m/m in April, although the ONS did point out that (hot) monthly rate was half of April 2022’s.^[ix]

Seeing these admittedly not great data, publications we read immediately turned to pencilling in more rate hikes and even calling for potential government pressure on businesses to lower prices. But before heading down those paths, we think it may be worthwhile to consider some potential mitigating factors.

On energy, price caps are set to change. We think these measures may—may—have limited rising prices' effects on the way up. But they have seemingly delayed relief on the way down. But now, consider: Ofgem set a new price cap on Thursday, effective in July, and it will be lower—£2,074.^[x] The Energy Price Guarantee is scheduled to rise from £2,500 to £3,000 concurrently, so the cap governing prices should switch this summer to a lower, Ofgem-set rate than consumers presently pay.^[xi] Whilst this system is pretty inefficient, in our view, it does suggest that wholesale price declines should ever so gradually start finding their way to consumers. At any rate, we think it is a little ironic that some commentators we follow call for government action to cool prices when there is ample—and widely accepted—evidence it is delaying their decline in other industries.^[xii] This is what our research shows is the paradox of price caps: In our experience, they often keep costs high.

Food prices’ fast rise added more than 2 percentage points to the year-over-year inflation rate, and its 1.4% m/m rise added 0.2 percentage point on a month-over-month basis.^[xiii] But as we noted here last month, much of this is likely tied to long-term contracts locked in during the height of shortage fears last year, as well as short-term pressures like the avian flu. As these pass, we think improvement should follow. Regardless, in our view, there is little chance a BoE rate hike does much to help.

Similarly, we think a rate hike wouldn’t reverse the double-digit rise in many UK consumers’ mobile phone and broadband bills, which skewed April communication prices up 8.0% m/m (7.9% y/y)—the fastest-rising category on a month-over-month basis.^[xiv] Telecoms base their rate changes on inflation (the economy-wide rise in prices), to which they add a small spread. The inflation rate they used to set prices was December 2022’s 10.5% y/y, so many consumers are seeing costs for these services rise in the neighbourhood of 14% this year.^[xv] That isn’t great news. But this addition of 0.2 percentage point to CPI’s 1.2% month-over-month rise is a one-time impact.^[xvi]

With all the negativity and continued alarm over UK prices, we don’t think it should take very much improvement to positively surprise markets. As the year continues and energy price caps reset, we think that should give some relief. In our view, food prices eventually easing should add more, and one-offs like a spike in broadband and mobile contract rates should fall away. We think it will likely take time for this to bring down high headline inflation rates. But given the dark outlook many commentators we follow have on the UK and specifically its prices, even a gradual cooling should be a positive surprise—much as the unseen and underappreciated improvements have been since last autumn.^[xvii]