Tag: #inflation

ICAEW chart of the week: Slowing inflation

My chart this week illustrates the slowing rate of inflation and how it should fall further once a big surge in prices between February and April 2022 falls out of the year-on-year comparison.

Step chart showing quarterly (annualised) and annual rates of consumer price inflation (CPI): Quarters to Apr 21, Jul 21, Oct 21 and Jan 22: +4.3%, +4.4%, +8.7%, +4.5% respectively adding up to equal +5.5% for the year to Jan 22. Quarters to Apr 22, Jul 22, Oct 22 and Jan 23: +19.1%, +8.6%, +12.5%, +0.8% respectively adding up to equal +10.1% for the year to Jan 23. Final column shows CPI Index increasing from 109.0 for Jan 21 to 114.9 for Jan 22 and then 126.4 for Jan 23.

The Office for National Statistics (ONS) reported that the annual rate of consumer price inflation (CPI) was 10.1% in January 2023, falling from 10.5% last month and down from a peak of 11.1% in October 2022, but much higher than the 5.5% annual rate of inflation for the year to January 2022.

Our chart breaks down annual inflation over the past two years to January 2023 into quarters, highlighting how inflation is likely to fall quite rapidly over the next three months as the big surge in prices following Russia’s invasion of Ukraine last year falls out of the year-on-year comparison.

Reported inflation this time last year was 5.5% for the year to January 2022. This can be broken down into quarterly rises (annualised) of 4.3% in the three months to April 2021, 4.4% in the quarter to July 2021, 8.7% in the quarter to October 2021 and 4.5% in the three months to January 2022. Inflation in that period was well above the Bank of England’s target range of 1% to 3%, as supply constraints drove prices higher as the domestic and global economies started to recover from the depths of the pandemic.

Reported inflation for the year to January 2023 of 10.1% can be broken down into quarterly rises (annualised) of 19.1% in the quarter to April 2022, 8.6% in the quarter to July 2022, 12.5% in the quarter to October 2022 and 0.8% in the three months to January 2023. The sharp jump in prices in the period from February to April 2022 was driven by a rapid rise in energy prices following Russia’s invasion of Ukraine that added to existing inflationary pressures, turbo charging the rate of inflation. Since then, prices across the economy have risen rapidly, although with wholesale energy prices retreating from their peak recently, the overall rate of price rises has slowed down significantly in the last quarter.

The chart also shows how the consumer price inflation index (the CPI Index) increased from 109.0 in January 2021 to 114.9 in January 2022 and to 126.4 in January 2023.

The chart doesn’t show the intermediate annual rates of inflation, although these can be calculated using the geometric average of the preceding four quarters. The annual rate increased from 5.5% in January 2022 to 9.0% in April 2022, then to 10.1% in July 2022 before reaching a peak of 11.1% in October 2022, following which it fell to 10.1% in January 2022. 

Successively dropping quarters from the previous year out of the year-on-year comparison and replacing them with price rises over the most recent quarter saw inflation rise as quarterly rises (annualised) of 4.3% fell out to be replaced by 19.1%, 4.4% by 8.6%, and 8.7% by 12.5%, before inflation fell over the last three months as 4.5% was replaced by 0.8%.

These ‘base effects’ mean that most commentators expect a sharp slowdown in the annual inflation rate over the next nine months as monthly and quarterly price rises over that time should be much lower than the comparatives falling out of the year-on-year calculation. The biggest fall is expected over the next three months, as even with a sizeable rise in domestic energy prices expected in the month of April 2023 as government support is withdrawn, price rises are expected to be much lower than the 19.1% annualised rate seen in the quarter to April 2022.

While the medicine of higher interest rates is no doubt playing a key part in restraining prices from rising as fast as they did last year, the Bank of England knows that arithmetic should be the biggest contributor to inflation coming down over the course of 2023.

This chart was originally published by ICAEW.

ICAEW chart of the week: Peak inflation?

Inflation is believed to have peaked last quarter before being forecast to fall significantly over the course of 2023. We hope.

Line chart showing annual inflation rates on a quarterly basis: 2021 Q1 0.6% Q2 2.1% Q3 2.8% Q4 4.9% 2022 Q1 6.2% Q2 9.2% Q3 10.0% Line switches from actual to forecast Q4 11.1% 2023 Q1 10.2% Q2 8.9% Q3 6.9% Q4 3.8%

Our first chart of 2023 is on the prospects for consumer price inflation (CPI) over the course of the coming year, based on the latest forecasts for inflation from the Office for Budget Responsibility (OBR) that were released on 21 December 2022.

The OBR’s calculations suggest that CPI should come down significantly over the next four quarters to reach 3.8% by the end of the year, ‘only’ 0.8% above the Bank of England target range of 1% to 3%. The return of inflation to more moderate levels should help stabilise an economy that is currently in a pretty bad place, although it is important to understand that prices will still be rising, just at a slower pace than they have been over the course of the past year.

The chart illustrates how inflation started to rise in 2021, from a below-target 0.6% in Q1, to 2.1% in Q2, then 2.8% in Q3, before jumping to 4.9% at the end of 2021. The Russian invasion of Ukraine in the first quarter of 2022 and its consequences for global energy prices drove the inflation rate even higher, to 6.2% in Q1, 9.2% in Q2 and 10% in Q3, before rising to a forecast peak of 11.1% in Q4 of 2022. The OBR then goes on to forecast that the rate of price increases experienced by consumers will moderate in the coming year, down to 10.2% in Q1, 8.9% in Q2, 6.9% and then 3.8% in the fourth quarter of 2023.

Of course, economic forecasts of this nature are inherently uncertain, especially given the role that volatile energy prices play, both in their own right but also as a cost input to many other products and services. For consumers, the withdrawal of the Energy Price Guarantee will mean energy bills are likely to rise significantly in the second quarter despite falling wholesale prices.

The chart does not extend into 2024, when the forecasts are even more uncertain than for the current year. The OBR suggests that inflation could turn negative during 2024 (Q1: 2.5%; Q2: 0.4%; Q3: -0.2%; Q4: -0.1%) and 2025 (Q1: -0.1%; Q2: -0.6%; Q3: -1.1%; Q4: -1.3%), before heading back to target in 2026 (Q1: -1.0%; Q2: -0.4%; Q3: 0.9%; Q4: 1.2%). Deflation brings with it a whole different set of economic challenges to be faced but, fortunately, forecasts are less accurate the further into the future they go. The hope is that the Bank of England will be able to time its switch in monetary policy actions from countering inflation to countering deflation just right in order to avoid this potential outcome.

Either way, the prospect of inflation coming down over the coming year is a positive amid an otherwise very bleak economic picture for the UK as we begin 2023.

This chart was originally published by ICAEW.

ICAEW chart of the week: Consumer Price Inflation

My chart this week looks at how the benchmark percentage used to determine the rise in the state pension and many welfare benefits from next April reached 10.1% in September 2022.

Line chart showing the CPI index over 4 years, together with the annual percentage change to each September. Sep 2018: 106.6 (intermediate quarters 107.1, 107.0, 107.9) Sep 2019: 108.5, +1.7% over prior year (108.5, 108.6, 108.6) Sep 2020: 109.1, +0.5% (109.2, 109.4, 111.3) Sep 2021: 112.4, +3.1% (115.1, 117.1, 121.8) Sep 2022: 123.8, +10.1%

The ICAEW chart of the week is on consumer price inflation, illustrating how the CPI index rose from 106.1 in September 2018 to 108.5 in September 2019, 109.1 in September 2020, 112.4 in September 2021 and 123.8 in September 2022. According to the Office for National Statistics (ONS), this meant that annual consumer price inflation was 1.7%, 0.5%, 3.1% and 10.1% for each of the four years to September 2022.

The percentage increase in the consumer price inflation index to each September is an important number as it is used to uprate most welfare benefits from the following April. In addition, under the triple-lock formula that has just been recommitted to by the government, it will be used to uprate the state pension in place of the statutory requirement for a rise in line with average earnings, which in September 2022 was 5.5%.

There has been speculation that the Chancellor of the Exchequer might try to restrict the uprating of welfare benefits (other than the state pension) to below inflation in order to meet his fiscal objectives. However, there is significant political pressure not to do so during a cost-of-living crisis that means many households are already struggling to pay their bills, even before the large rise in energy prices this month.

In theory, the sharp upward slope in the index over the last year provides some hope for both consumers and the Bank of England, as price increases from a year earlier fall out of the index, at least from November onwards given the energy price guarantee that means domestic energy prices should be flat for the following six months. With petrol and diesel prices appearing to moderate, and the ‘medicine’ of higher interest rates starting to take effect, the hope is that prices will rise less rapidly than they have this year, and so cause the annual rate of inflation to fall in the first half of next year.

Having said that, if recent events have taught us anything it is that our ability to predict the future is far from perfect.

This chart was originally published by ICAEW.

ICAEW chart of the week: Inflation around the world

This week we look at how inflation is racing upwards across the world, with the UK reporting in April one of the highest rates of increase among developed countries.

Bar chart showing inflation rates by G20 country: Russia 17.8%, Nigeria 16.8%, Poland 12.4%, Brazil 12.1%, Netherlands 9.6%, UK 9.0%, Spain 8.3%, USA 8.3%, India 7.8%, Mexico 7.7%, German 7.4%, Canada 6.8%, Italy 6.0%, South Africa 5.9%, France 4.8%, South Korea 4.8%, Indonesia 3.5%, Switzerland 2.5%, Japan 2.4%, Saudia Arabia 2.3%, China 2.1%.

Inflation has increased rapidly over the last year as the world has emerged from the pandemic. A recovery in demand combined with constraints in supply and transportation has driven prices, with myriad factors at play. These include the effects of lockdowns in China (the world’s largest supplier of goods), the devastation caused by the Russian invasion in Ukraine (a major food exporter to Europe, the Middle East and Africa), and the economic sanctions imposed on Russia (one of the world’s largest suppliers of oil and gas).

As the chart shows, the UK currently has – at 9% – the highest reported rate of consumer price inflation in the G7, as measured by the annual change in the consumer prices index (CPI) between April 2021 and April 2022. This compares with 8.3% in the USA, 7.4% in Germany, 6.8% in Canada, 6.0% in Italy, 4.8% in France and 2.4% in Japan. 

The UK’s relatively higher rate partly reflects the big jump in energy prices in April from the rise in the domestic energy price cap, which contrasts with France, for example, where domestic energy price rises have been much lower (thanks in part to state subsidies). The UK inflation rate also hasn’t been helped by falls in the value of sterling, making imported goods and food more expensive.

Other countries shown in the chart include Russia at 17.8%, Nigeria at 16.8%, Poland at 12.4%, Brazil at 12.1%, Netherlands at 9.6%, Spain at 8.3%, India at 7.8%, Mexico at 7.7%, South Africa 5.9%, South Korea at 4.8%, Indonesia at 3.5%, Switzerland at 2.5%, Saudi Arabia at 2.3% and China at 2.1%. For most countries, the rate of inflation is substantially higher than it has been for many years, reflecting just how major a change there has been in a global economy that had become accustomed to relatively stable prices in recent years. 

This is not the case for every country, and the chart excludes three hyperinflationary countries that already had problems with inflation even before the pandemic, led by Venezuela with an inflation rate of 222.3% in April, Turkey with a rate of 70%, and Argentina at 58%.

Policymakers have been alarmed at the prospect of an inflationary cycle as higher prices start to drive higher wages, which in turn will drive even higher prices. For central banks that has meant increasing interest rates to try and dampen demand, while finance ministries have been looking to see how they can protect households from the effect of rising prices, particular on energy, whether that be by intervention to constrain prices, through temporary tax cuts, or through direct or indirect financial support to struggling households.

Here in the UK, both the Bank of England and HM Treasury have been calling for restraint in wage settlements as they seek to head off a further ramp-up in inflation. They hope that inflation will start to moderate later in the year as price rises in the last six months start to drop out of the year-on-year comparison and supply constraints start to ease, for example as oil and gas production is ramped up in the USA, the Middle East and elsewhere to replace Russia as an energy supplier, and as China emerges from its lockdowns.

Despite that, prices are likely to rise further, especially in October when the energy price cap is expected to increase by 40%, following a 54% rise in April. This is likely to force many to make difficult choices as household budgets come under increasing strain.

After all, inflation is much more than the rate of change in an arbitrary index; it has an impact in the real world of diminishing spending power and in eroding the value of savings. 

This chart was originally published by ICAEW.

ICAEW chart of the week: Real interest rates

The ICAEW chart of the week looks at how real interest rates – net of inflation – remain stubbornly negative despite recent increases in the Bank of England base rate.

Chart with three lines - nominal yields on government debt, the Bank of England base rate and real yields on government debt. See text for details.

A feature of the economy since the financial crisis has been negative real interest rates, with the Bank of England reporting a -2.33% implied spot yield on 10-year government gilts as of 30 April 2022. This compares with a base rate of 0.75% on that day (since raised to 1%) and a nominal yield of +1.9%. With further increases in interest rates likely as the Bank of England seeks to bring inflation under control it is possible that real interest rates will become less negative over the next few months, at least assuming inflation peaks and doesn’t accelerate out of control.

Negative real interest rates are generally considered to be stimulative to the economy, reflecting the monetary policy support that the Bank of England has been providing since the financial crisis almost a decade and a half ago. Economic theory suggests that this should encourage spending and investment, as the nominal interest earned on savings will not be sufficient to offset the erosion in the value of money as prices rise over time.

The chart highlights how real interest rates were -2.59% in January 2020, before falling to almost -3.08% in June 2020 and bouncing around between -2.50% and -3.00% until November 2021 when they fell to -3.33%. They have since increased to -2.33% in April and to -2.20% as of 10 May 2022. Over that same period, nominal interest rates similarly based on government bond yields have fallen from 0.53% in January 2020 to 0.13% in July 2020 before increasing to between 0.3% and 0.4% until January 2021 after which they bounced between 0.8% and 1.0% until December 2021 since when rates have gradually increased to 1.92% on 30 April 2022, falling slightly to 1.86% on 10 May 2022. During this time, the Bank of England base rate was reduced from 0.75% in January 2020, to 0.25% and then 0.10% in March 2020 where it stayed until increasing to 0.25% in December 2021, to 0.50% in February 2022 to 0.75% in March 2022 and to 1.00% in May 2022.

The yields used in the chart are only one way of measuring real and nominal interest rates, and it is important to note that the former depend on the inflation expectations of market participants at particular points in time, which are not the same as the actual rates of inflation that are or will be experienced.

The challenge for the Bank of England over the next few months in tackling the current surge in inflation is how to take away the economic stimulus theoretically provided by negative real interest rates without causing a collapse in asset prices and a potential recession. A series of tough calls for even the most hardened policy makers.

This chart was originally published by ICAEW.

ICAEW chart of the week: Consumer Prices Index

My chart this week looks at how price rises have accelerated over the last few months, with consumer price inflation reaching 4.2% in October, the highest it has been for a decade.

Line chart showing how the Consumer Prices Index has increased from 106.7 in Oct 2018 to 107/6 in Apr 2019 to 108.3 in Oct 2019 (a +1.5% increase over a year earlier) to 108.5 in Apr 2020 to 109.1 in Oct 2020 (up 0.7% over the year) to 110.1 in Apr 2021 to 113.6 in Oct 2021 (a 4.2% annual increase).

The Office for National Statistics published its latest estimates for inflation on Wednesday 17 November, reporting a 12-month increase in the Consumer Prices Index (CPI) of 4.2% and a 12-month increase in the Consumer Prices Index including owner occupiers’ house costs (CPIH) of 3.8%, both of which are the highest they have been since November 2011 when CPI was 4.8% and CPIH was 4.1%.

CPI and CPIH are calculated using a basket of goods and services to assess the level of inflation experienced by consumers, with the current index set to 100 in July 2015.

The ICAEW chart of the week shows how CPI fell before increasing from 106.7 in October 2018 to 107.6 in April 2019 and 108.3 in October 2019, an annual increase of 1.5% that was within the 1% to 3% Bank of England target range. This was followed by smaller increases to 108.3 in April 2020 and 109.1 in October 2020, a 0.7% annual increase in CPI driven in part by the pandemic. The index hovered around that level for several months until starting to increase more rapidly from March onwards as the economy started to re-open, reaching 110.1 in April 2021 and continuing to increase sharply to 113.6 in October 2021, an annual increase of 4.2%.

The Governor of the Bank of England is required to write to the Chancellor of the Bank of England whenever inflation is more than 1% above or below the 2% target and he did so on 23 September when inflation reached 3.2% and he will again now that it has reached 4.2%. Part of the explanation he has given and will give are ‘base effects’, where price discounting during 2020 at the height of the first and second waves of the pandemic suppressed some of the inflation that is being experienced now.

Further letters are likely over the next few months as even if prices don’t rise any further, given how the index bounced around the 109 level between September and March 2021. This means inflation should continue to stay substantially above 3% for the next four months or so unless prices were to fall again, which is unlikely given how global commodities and supply constraints continue to feed into rising domestic prices. A 12-month CPI-inflation rate of 5% appears more than likely at some point in the next few months.

The Bank of England’s Monetary Policy Committee (MPC) isn’t panicking at this stage given that the annualised rate of inflation over the last three years (comparing October 2021 with October 2018) is an almost on-target 2.1% and their expectation that inflation rate will come down once the flat inflationary period of a year ago starts to drop out of the comparison. However, they are sufficiently concerned about the steep slope in the CPI in the last few months to signal that interest rates may need to rise if prices continue to increase at the pace seen in recent months.

The MPC’s original plan was to hang tight through what they hoped would be a short inflationary spurt as the economy emerges from the pandemic. In the event it looks like they won’t be able to hold that line, with higher interest rates a distinct possibility in the coming months.

This chart was originally published by ICAEW.

ICAEW chart of the week: UK inflation

This week’s chart takes a look at UK inflation following news that the annual rate of inflation more than doubled in April to 1.5%, more than twice the 0.7% reported for the previous month.

Chart: CPI increasing from less than 0.5% in Apr 2016 to over 3% in Oct 2017 before falling to close to zero in Oct 2020, zigzagging to 0.7% in Mar 2021 and then jumping to 1.5% in Apr 2021. Compared with five year annualised rate gradually increasing from 1.5% in 2016 to close to just under 2% now.

The headline rate of inflation doubled this week from 0.7% to 1.5%, giving rise to concerns about the economic recovery. Economists aren’t getting worried just yet, but are they right to be so sanguine? 

This scale of this jump partly reflects the timing of the first and current lockdowns, as inflation is typically measured by comparing prices with the same month a year previously, with significant changes both this year as the UK started to emerge from its third lockdown and a year ago as it was entering its first. Some commentators have pointed out that the temporary cut in VAT on restaurant food and leisure activities help prevent the jump from being even higher.

Our chart compares the annual rate of Consumer Price Index (CPI) inflation with a more stable measure, which is the annualised rate of CPI inflation over a five-year period. This is less susceptible to short-term swings in the economy, but as the chart shows, medium-term inflation has been gradually rising over the past five years even as headline rates on an annual basis fell over the last four years before the pandemic.

This perhaps explains some of the relaxed responses from economists about the sudden burst in inflation in the last month, given the annual rate of increase still remains below the medium-term trend, despite the current extraordinary economic circumstances.

Of course, that is not to say that inflation might not become a problem as the UK emerges further from lockdown. Many businesses have closed over the last year, particularly in the retail sector, while those that have survived will be looking to repair their balance sheets – a recipe for higher prices as constrained supply meets higher post-lockdown demand from consumers. Only time will tell whether this will feed into sustained higher levels of inflation or will jump be a temporary adjustment that falls out of the headline rate again in a year or so’s time.