UK Inflation Slowed, Sped and Disappointed

Wednesday, the UK’s Office for National Statistics (ONS) published its widely watched Consumer Price Index (CPI)—which has been at the forefront of many pundits’ minds for nearly two years. For as much as fast-rising prices have plagued consumers and businesses across much of the world in the last year, Britain has arguably been hit the hardest. And in April, that seemingly continued, as headline inflation slowed—but not as much as forecast—and core inflation actually accelerated. Predictably, the data led to many forecasts of higher rates to come, calls for more government action to rein prices in—and a general deepening in malaise. These data aren’t terribly pretty. But in our view, while it may take time to develop, there is ample room for positive surprise on UK prices from here.

April’s headline UK CPI slowed bigtime—from 10.1% y/y in March to 8.7% in April, -2.4 percentage points below October 2022’s peak.^[i] But this seemingly big plus was muted by the fact almost every observer knew a sharp improvement was coming—largely tied to energy prices. As we have discussed, the UK government has two competing price caps in place for households. Energy regulator Ofgem has long capped household energy prices, currently at an annual £3,280 through June’s end. But the average household isn’t paying that, considering the UK government’s Energy Price Guarantee (EPG, unveiled in October 2022) caps prices lower, presently at £2,500 annually. Regardless, a swift decline in energy prices globally means the UK government didn’t need to lift these caps this year—unlike 2022. Hence, the year-over-year household energy inflation rate slowed dramatically (from 85.6% y/y in March to 24.3% in April).^[ii]

Furthermore, even last month’s big slowing missed forecasts. Analysts had expected prices to decelerate to 8.2% y/y in April. Just a couple weeks ago the Bank of England said it anticipated 8.4%.^[iii] Why the miss? Many noted food prices remain hot, rising 19.0% y/y, a microscopic slowdown from 19.1% in March. 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. 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.

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

On energy, price caps are set to change. These measures may—may—have limited rising prices effects on the way up. But they have seemingly delayed relief on the way down. Consider: Ofgem set a new price cap on Thursday, effective in July, and it will be lower—£2,074. The EPG is scheduled to rise from £2,500 to £3,000 concurrently, so the cap governing prices will likely switch this summer to a lower, Ofgem-set rate than consumers presently pay. While this system is pretty inefficient, in our view, it does suggest that wholesale price declines will ever so gradually start finding their way to consumers. At any rate, we find it a little ironic that some call for government action to cool prices when there is ample—and widely accepted—evidence it is delaying their decline in other industries. This, folks, is the paradox of price caps: 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.^[iv] 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, improvement should follow. Regardless, there is little chance a Bank of England rate hike does much to help.

Similarly, 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.^[v] The inflation rate telecoms used to set prices was December 2022’s 10.5% y/y, so many consumers are seeing costs for these services rise in the neighborhood of 14% this year.^[vi] 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.

With all the negativity and continued alarm over UK prices, it likely won’t take very much improvement to positively surprise markets. As the year continues and energy price caps reset, that should give some relief. Food prices eventually easing should add more, and one-offs like a spike in broadband and mobile contract rates should fall away. It will take time for this to bring down high headline inflation rates. But given the dark outlook many 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.