After Wednesday’s news that inflation fell below 5% in October, the Prime Minister was quick to declare victory over inflation and investors were swift to increase their bets that the Bank of England will be cutting interest rates by the middle of next year.
But there are still plenty of inflation risks out there and the fight against inflation won’t be won until it has fallen to 2%.
The sharp drop in consumer price inflation from 6.7% in September to 4.6% in October was good news. It left inflation well below the 40-year high of 11.1% in October 2023 and more than half the rate of 10.1% in January. The latter explains why the Prime Minister has been gloating that he has achieved his target of “halving inflation” this year.
Most households won’t share his glee. Although inflation has come down, this doesn’t mean that households are paying less for all the goods and services they buy. Instead, it means prices are still rising, but just at a slower pace than before.
Admittedly, some prices have actually fallen. Electricity and gas prices this October were 22% lower than last October. And petrol prices were 18% lower than in July 2022.
But gas and electricity prices were still 48% higher than in January 2022 and petrol prices were 17% higher. Moreover, food prices were 25% higher. The most recent falls in prices are therefore only reversing part of the previous large rises.
What’s more, it is disingenuous of the Prime Minister to claim that he is responsible for the fall in inflation. Almost all of the fall since January has occurred in areas where prices are mostly determined by events overseas, such as utility and petrol prices.
Only a small part can be explained by domestic events. And if there is any credit to be dolled out there, it should go to the Bank of England who has helped to crimp domestic inflation by raising interest rates. The Prime Minister hasn’t played much of a role.
And he of all people should know that the Bank of England has responsibility for keeping inflation at 2%, not the 5% he has been aiming for. Indeed, the government chooses the inflation target!
The Bank of England is being more circumspect as it knows it is too soon to declare victory over inflation. That’s why Bank Governor, Andrew Bailey, recently said “it is much too early to be thinking about [interest] rate cuts”.
In particular, there remains the risk that the events in the Middle East spark another leap in oil and wholesale gas prices. That would mean inflation takes longer to fall from 4.6% to the 2% target.
The wholesale gas price has risen by 23% since the conflict began. That means utility prices in the UK are unlikely to fall when the Ofgem price cap is next reset on 1st January 2024. Admittedly, the oil price has declined by 4%. That seems odd, but it is presumably because Israel doesn’t produce much oil, which means the supply for the rest of the world is largely unchanged.
But if the large oil producers of Iran, Saudi Arabia or United Arab Emirates were to become actively involved in the conflict, then it wouldn’t be long before prices at the UK’s petrol pumps rose again.
If these risks don’t turn into reality, then it's possible inflation will fall to the 2% target early in the second half of next year. And if that happens without the UK experiencing a painful recession, then that would be a good result all round.
But inflation is one of those things that feels like it is under control until it suddenly isn’t. And given that the Bank of England’s reputation has been dented by inflation consistently being above the 2% target for the past two-and-a-half years, it will want to be mighty sure it’s finished the job before cutting interest rates. That’s why I’m not expecting the Bank to reduce interest rates from the current 5.25% until late in 2024. That will be when to declare victory over inflation.
