CPI inflation rose to an annual 3.3% in November and remains on course to reach 4% in early 2011, reflecting the impact of soaring commodity prices, the VAT hike and a stubborn “core” trend, which continues to defy Bank of England predictions of a slowdown in response to economic slack and fading exchange rate effects.
The November rise was driven by a pick-up in goods inflation from 2.6% to 2.9% as the food, alcohol and tobacco component moved up from 5.0% to 5.8% and non-energy industrial goods inflation firmed from 1.1% to 1.4%, mainly as a result of price hikes for clothing and household goods. Food inflation remains likely to reach 7% soon, as suggested in a post in September. Energy inflation fell from 4.0% to 3.5% but is heading significantly higher as recent rises in gas and electricity tariffs take effect. A further increase in overall goods inflation is also suggested by CBI industrial price expectations – see first chart.
Services inflation moderated from 3.8% to 3.7%, mainly reflecting a slowdown in transport services, but the VAT hike is likely to push it above 4% in the new year.
“Core” CPI inflation – excluding energy, food, alcohol and tobacco – was stable at 2.7% in November.
Key influences on the headline CPI rate over the next few months will be:
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Higher VAT pass-through than a year ago – estimated upward impact of up to 0.6 percentage points (pp). The Bank’s regional agents’ survey reports that most firms plan to pass on the hike in full.
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Announced increases in home energy tariffs – about 0.4 pp by next spring.
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Higher food commodity costs – 0.2 pp assuming annual food inflation reaches 7%.
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Higher vehicle fuel costs, with unleaded likely to rise above £1.25 per litre – little impact because of a similar increase a year ago but previously-expected downward effect no longer operative.
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Secondary food price effects via the “catering services” CPI component – 0.1 pp assuming annual inflation rises to about 4% from 3.3% currently (up from 3.0% in June).
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Accelerating housing rents – 0.1 pp assuming a rise in annual inflation from 1.5% in November to about 3%. Private-sector rents are growing strongly, according to the RICS letting agents' survey – second chart.
High inflation threatens to slow the economic recovery by squeezing real incomes and money balances. By refusing to raise interest rates because of coming fiscal tightening, the Bank is encouraging high pass-through of cost-push pressures and a rise in inflationary expectations, thereby entrenching the current overshoot. Far from supporting the economy, its actions risk damaging medium-term growth prospects.
