UK consumer price inflation climbed further to an annual 4.4% in July, well above the consensus forecast of 4.1%. While food was the largest contributor to the monthly increase, “core” inflation – excluding food, energy, alcohol and tobacco – also rose significantly, reaching an annual 1.9%.

Why does inflation keep overshooting MPC and consensus expectations?

Inflationary pressures often strengthen in the early stages of economic slowdowns, for at least four reasons. First, output is typically above its trend or potential level when the slowdown begins; a fall beneath trend is needed to stem inflation momentum. Secondly, productivity tends to slow along with output, as employers are initially reluctant to cut workforces, implying faster growth in unit labour costs. Thirdly, monetary expansion often remains strong well into an economic downswing; ample liquidity accommodates price increases and may boost inflation expectations. Fourthly, a slowing economy may be associated with a fall in the exchange rate, putting upward pressure on import prices.

All these factors have been at work recently but exchange rate weakness has played a particularly important role in pushing up core inflation and magnifying the domestic impact of rising global food and energy prices.

It is too late for the MPC to influence coming high inflation outcomes, which reflect past policy mistakes. Monetary growth has slowed to a level consistent with inflation returning to target over the medium term, while the effective exchange has stabilised since April. Barring a monetary reacceleration or renewed sterling weakness, the MPC should hold to a stable course despite the obvious damage to its credibility from the current overshoot.