Britain’s cost of living crisis is still raging but inflationary pressures are now easing. Fears of a wage-price spiral look overblown. Bank of England interest rate setters will take comfort and the peak in official borrowing costs is close at hand.
Those were the three big conclusions from the latest Office for National Statistics data showing a sharper than expected drop in the annual consumer prices index measure of inflation, from 10.5% in December to 10.1% in January. Prices normally fall in the first month of the year due to post-Christmas sales, but the drop was larger in January 2023 than in January 2022.
Prices are still rising fast, and poorer households are feeling the impact more than their richer neighbours. The annual rate of food inflation stands at 16.7%, while the cost of gas is up almost 130% on a year ago. A falling inflation rate doesn’t mean prices are coming down, it simply means they are rising less quickly.
That said, there are now clear signs that inflationary pressures are abating. The headline rate of CPI inflation is still running at five times its official 2% target but it fell for a second month. Core inflation – which excludes food, energy, alcohol and tobacco – dropped from 6.3% to 5.8%.
Threadneedle Street has been closely monitoring inflation in the service sector to see if businesses are granting higher pay awards to workers and then passing on the extra costs to their customers.
It will be of some relief to the Bank’s monetary policy committee that service sector inflation fell from 6.8% in December to 6% in January. The ONS also monitors inflation at the early stage of the production process by measuring the prices manufacturers pay for fuel and raw materials, and the cost of goods leaving factory gates. Both are still rising at double-digit rates but down from their peaks last year.
Further declines in inflation can be expected in the coming months. Inflation is calculated by measuring prices increases in the latest 12 months and there were strong monthly increases in the first half of 2022, in large part due to the rising cost of energy that followed Russia’s invasion of Ukraine. Those increases are unlikely to be repeated this year, so inflation will mechanically fall. Analysts believe it could be back to target by the end of the year.
It is not all good news. Prices are still rising a lot faster than wages, continuing the squeeze on living standards. The reason firms are unable to pass higher wage costs on to their customers is that consumers are cutting back on their spending as the economy stalls. The recent upward trend in business failures is set to continue.
But in its monetary policy report earlier this month, the Bank said it would need to carry on increasing interest rates if there was evidence of more persistent inflationary pressure. There is little in the latest ONS data to suggest this is the case and no real justification for borrowing costs to rise further.
