Inflation is being driven up by a variety of external factors despite underlying sluggish demand in the economy.
The Consumer Price Index (CPI) annual inflation reverted back to 2.7% in May after slowing markedly in April to 2.4%. The RPI edged up to 3.1% in May from 2.9% in April. By far the largest upward contribution to the inflation figure came from transport costs, particularly air transport and motor fuels. Air fare increased by 22% between April and May compared with a much more muted rise of 1.4% during same period in 2012. This increase was due to the Easter holiday falling in May rather than April this year. Petrol and diesel prices both fell between these months (by 3.1p and 3.2p a litre respectively) but they fell by more (4.5p and 4.4p a litre respectively) last year. Further upward pressure stemmed from clothing & footwear where prices rose by 1.2% between April and May 2013 and fell by 0.1% during same two months in 2012. The increase was due to price rises in some outdoor clothing this year as May temperatures fell below seasonal norms.
Inflation has been above the Bank of England’s 2% target for an extended period despite the weak output growth, domestic demand and wage growth. Inflation is forecast to rise further and may reach 3% in the next few months. The projected increase in above-target inflation reflects rises in factors such as utility cost, administrated and regulated, food and commodity prices.
Energy suppliers are expected to continue passing on non-energy costs to consumers. These include costs such as the maintenance of networks. The Bank of England estimates this could lead to an increase of 5% in energy prices both this autumn and for the following two years. We might therefore see further utility prices hikes announced by the energy suppliers during winter this year.
Utility inflation will remain above 4% for the rest of the year and will average 3% in 2014. Domestic energy prices are affected by whole sale prices and other cost related to maintenance and investment of distribution links.
Administrative and regulated prices which are determined by the government contributed 1 percentage point to the overall inflation and are expected to rise at similar rates in the next few years, mainly accounted for by tuition fees and energy prices.
Food prices have risen since mid-2012 as wet weather in the second half of 2012 pushed up seasonal food prices. Weather in 2013 has not been any better with the overall wheat harvest expected to fall by 30% this year and remain below the average in 2014. Also, international grain prices rose in mid-2012 as bad weather affected the harvest globally. Hence, food price inflation is expected to remain high in coming months.
Oil prices have been favourable recently as North Sea oil production picked up and global commodity demand has recently been less favourable amid weaker than expected growth in some big countries such as China. In addition, the higher supply from US is offsetting the continued political tensions in the Middle East. Domestic Gas prices, on the other hand, have been volatile. They rose in the first quarter of this year as the demand for gas increased due to the cold weather and they fell back again in the third quarter. Wholesale prices may rise towards the end of this year due to low inventories and disruptions to imports.
Another upside risk for the inflation is associated with quantitative easting (QE). If the new governor of Bank of England (Mark Carney), who is starting his tenure in July, is able to persuade the MPC to implement additional QE this will weaker sterling further and push up inflation.
Written by Nowres Mohatam