On the surface, UK inflation in 2023 is becoming similar to that of the 1970s, when everyone talked about a “British disease” making the country the “sick man” of Europe.
Stubbornly high inflation that eclipses rates in other countries. Contracts, such as mobile phones, linked to inflation, amplifying price pressures. The authorities struggling to control household costs. And wages following prices higher.
Certainly, UK inflation seems to be stickier than that of other countries. This has been caused by a combination of robust spending at a time when labour markets are tight — also a problem for the US — and the residual effects of a huge rise in European wholesale gas prices last year.
Stephen King, senior economic adviser to HSBC and author of We Need to Talk about Inflation, was scathing following the release of new data by the Office for National Statistics on Wednesday.
In April, the inflation rate stood at 8.7 per cent, greatly exceeding the 8.4 per cent expected by the Bank of England.
“It doesn’t look good, does it?” King said. “Depressed growth, not helped by Brexit. Real wage resistance. Core inflation the highest in decades. The BoE admitting it’s been using a model that hasn’t worked well of late. Policy rates still very low relative to 6.8 per cent core inflation . . . oh dear.”
For three consecutive months, the BoE has been caught out, failing to understand the short-term dynamics in prices. In February, the central bank expected inflation to fall to 9.2 per cent by March but it remained at 10.1 per cent.
When the BoE revised its forecasts this month, it built in new margins for error to improve accuracy. Privately, officials said the bank had tried everything to ensure the forecasts were not again too optimistic.
Andrew Bailey, BoE governor, conceded on Tuesday that the bank had “very big lessons to learn” on controlling inflation and its forecasting.
He said the failure to understand immediate price pressures in food were partly the result of adverse weather in Morocco, which had affected supply chains.
But he also accepted that the BoE had not realised that food manufacturers had locked in long-term wholesale contracts on food global commodity prices, which were close to their peak of last year.
Adding to the list of problems, it is clear the governor also did not see the latest month’s 1.2 per cent rise in UK prices coming. Nor did he expect price rises to be as broad, driven higher by increased costs of second-hand cars, large rises in mobile phone prices, as well as books, sports and gardening equipment and pets products.
Even before the latest forecast errors, BoE officials had been under pressure to explain themselves to MPs at the House of Commons’ Treasury committee on Tuesday.
Although Bailey said the bank had already used its judgment to push its forecasts higher he was criticised by Harriett Baldwin, the committee chair, for using a model solely based on data that reflected 30 years of relative price stability.
Huw Pill, BoE chief economist, said the central bank was studying historic data carefully for insight into how to control inflation. “We do think about [whether] we should be using models or revisiting frameworks that were applied to the data of the 1970s and 1980s,” he said.
“But crucially, while there may be something to learn from that, there are also reasons to think that experience is not immediately relevant,” Pill added.
Inflation remained persistent in those decades, Pill said, because companies and employees began to expect inflation would remain at high levels, and set prices and demanded wage increases accordingly.
Even though Bailey has accepted that a wage-price spiral is amplifying inflation, his chief economist said the current situation was different to the 1970s.
“The structure of the labour market is very different . . . and in particular the regime in which monetary policy is conducted is very different,” Pill said.
The BoE has stressed that most of the inflation has come from sharp rises in the price of gas and food, which the UK imports and the central bank has no control over.
As economists pointed out on Wednesday, the problem with the BoE blaming inflation on imported energy and food prices is that it is becoming increasingly inconsistent with the data.
Core inflation jumped from 6.2 per cent in March to 6.8 per cent in April when the average of economists’ expectations predicted it would remain constant.
Official figures also showed that the goods and services that contained few imported elements were adding increasingly to the overall inflation rate.
In April, the ONS said items that had less than a 10 per cent import intensity, such as housing rents, contributed 1.76 percentage points to the 8.7 per cent inflation rate. This was up from 1.38 percentage points in March and the highest level since the series was first published in 2006.
Allan Monks, UK economist at JPMorgan, said this was alarming and would prompt the BoE to raise interest rates further.
“[The data] cannot be described as a one-off or simply as an indirect byproduct of food and energy price gains, as the BoE and the doves have tended to suggest up until very recently,” Monks said.
The echo of times past spooked financial markets on Wednesday, sending expectations of future interest rate sharply higher. Financial markets predict rates will rise to 5.3 per cent by the end of the year.
This might be over-egging the problem, according to Sandra Horsfield, UK economist at Investec, who expects another quarter-point rise to 4.75 per cent in June.
In a time of 1970s-style stagflation, with little growth and high inflation, she said: “Little can be ruled out, but it is questionable that slamming that much harder on the brakes is necessary.”
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