The fall in CPI inflation from 8.7% in May to 7.9% in June announced on Wednesday morning may have got the Prime Minister and the Governor of the Bank of England dancing for joy around their respective breakfast tables. But there is a long way to go before they can take a bow.
Any musical shapes thrown by Rishi Sunak and Andrew Bailey yesterday morning (I’ll leave you to imagine if their styles are more Michael Gove or Theresa May) were probably partly because they know that inflation will almost certainly take another big step down in July. Due to the fall in the Ofgem price cap that lowered utility prices for all households from July 1, I suspect that CPI inflation in July will fall to around 6.5%.
That would leave the Prime Minister on track to meet his pledge to halve inflation from 10% to 5% this year. And it would mean that instead of being more than five times the Bank of England’s 2% inflation target, inflation would suddenly be “only” three and a bit times the target.
That said, there are five reasons why Sunak and Bailey will probably be dancing on their own for a while yet.
First, most people aren’t experiencing much relief. If inflation is falling but is still above zero, it doesn’t mean that prices are falling. Instead, it just means that prices aren’t rising as fast as they were. And prices of lots of important items are still rising at a painful pace. In the year to June, medical products prices rose by 11.6%, food prices by 17.3% and car insurance prices by 47.9%.
Out of the 120 main categories in the consumer price index (CPI), the level of prices was lower this June than last June in only five. Liquid fuel prices (i.e. heating oil) were 45.6% lower, petrol prices were 22.7% lower, umbrella/luggage/handbag prices were 1.5% lower, laptop prices were 0.5% lower and motorcycle/bike prices were also 0.5% lower.
Second, people in the UK are still in a worse position than people in the US and Europe. CPI inflation in the UK is still more than two-and-a-half times higher than the rate of 3.1% in the US and is almost one-and-a-half times higher than the rate of 5.5% in the euro-zone. I put this down to a combination of the effects of the pandemic, the UK’s greater tendency to accept higher inflation and Brexit.
Third, while I think that UK inflation will continue to fall, I doubt it will fall all the way to the 2% target until May 2024. That means households will have to stomach almost another year of overall consumer prices rising at a faster rate than usual.
Fourth, inflation will probably only fall all the way to 2% next year if the Bank of England raises interest rates further and keeps them high for around 12 months. The Bank has already raised interest rates from 0.10% in November 2021 to 5.00%. What’s more, I think it will raise rates to 5.50% in the coming months. This is boosting the interest that savers earn on their savings, but it is also dramatically raising the amount of interest that borrowers are paying on their mortgages, credit cards and other loans.
Fifth, because higher interest rates mean that households have less money to spend on other things, I still think that the economy will fall into a recession later this year. This will probably be a short and shallow recession compared with previous recessions. But it will probably mean that some people lose their jobs and the unemployment rate rises from 4.0% now to around 4.5%. As I explained in these pages a month ago, the less painful ways of lowering inflation by increasing the number of available workers or boosting productivity can’t be relied on.
Just to be clear, I’m all for dancing, especially in kitchens. But the Prime Minister and Bank Governor should save their best moves for next year. Only then will inflation be at rates that mean people don’t have to think or worry about it.
Paul Dales is chief UK economist of independent global research consultancy Capital Economics
