Press release

19 Feb 2020 London, GB

Surprise as consumer price inflation spiked to six-month high of 1.8% in January

A significant upward surprise as consumer price inflation jumped to a six-month high of 1.8% in January, from a 37-month low of 1.3% in December, marking the first rise in inflation since last July.

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  • A significant upward surprise as consumer price inflation jumped to a six-month high of 1.8% in January, from a 37-month low of 1.3% in December, marking the first rise in inflation since last July.
  • Some rise in inflation in January had been expected due to unfavourable base effects – inflation had fallen particularly sharply in January 2019 when Ofgem’s cap on consumer energy prices came into effect. However, it was also lifted by higher petrol prices and a smaller-than-usual drop in airfares after the usual spike up in December for the holidays.
  • Additional upward pressure on inflation in January came from clothing and footwear prices, and restaurants and hotels. Core inflation rose to 1.6% in January from 1.4% in December.  
  • The spike in inflation to 1.8% in January is obviously unhelpful for consumer purchasing power, compounded by a further dip in earnings growth in the three months to January.
  • The spike in inflation to 1.8% in January is unlikely to stand in the way of the Bank of England cutting interest rates, should hard data fail to show the economy picking up significantly over the first quarter. In fact, the Bank of England had forecast inflation to rise to 1.8% in the first quarter before falling back to 1.3% in the second quarter in its January Monetary Policy Report. However, we retain the view that the Bank of England is most likely to keep interest rates on hold at 0.75% throughout 2020. We expect the economy will see some pick-up in activity through the early months of 2020 while likely increased fiscal stimulus in the Budget is seen to give another reason for the Bank of England to sit tight.  
  • Price pressures further down the price chain also picked up in January but were still relatively contained overall and do not look alarming for consumer price inflation. Producer input prices rose 2.1% year-on-year as they rose 0.9% month-on-month (largely due to a spike in the price of imported metals). Meanwhile, the annual increase in producer output prices was still relatively limited although it rose to 1.1% from 0.9% in December as they rose 0.3% month-on-month.
  • We suspect inflation could move back down in February. Some of January’s rise was due to prices for airfares, hotels and restaurants and clothing and footwear falling back less than usual in January, and that could unwind in February. Also, oil prices have fallen back markedly overall so far in February compared to January.
  • Inflation should be helped in the second quarter by favourable energy price developments and lower water bills. Consequently, we believe inflation is likely to get back below 1.5% in the second quarter and possibly get as low as 1.3% in the third quarter.
  • Inflation is expected to trend gradually up during the latter months of 2020, but it looks unlikely to reach the Bank of England’s 2.0% target rate. We see inflation ending 2020 around 1.7%.
  • Domestic inflationary pressures are expected to be limited over the next few months at least due to spare capacity following recent soft economic activity, which is likely to constrain some companies’ pricing power. Earnings growth has also recently moderated. An overall pick-up in sterling in recent months should also help limit inflation, although the pound has recently fallen back from its peak levels seen in the aftermath of December’s decisive General Election result. This came amid increased market expectations that the Bank of England could cut interest rates early in 2020, and possibly as early as 30 January. Meanwhile, oil prices are expected to be little changed overall in 2020 compared to 2019.

Howard Archer, chief economic advisor to the EY ITEM Club, comments:

“Consumer price inflation unexpectedly spiked to a six-month high of 1.8% in January from 1.3% in December, which had been the lowest level since November 2016. Inflation had previously weakened to December’s level from 1.5% in November and October, 1.7% in September and August, and an equal 2019-high of 2.1% in July. Consumer price inflation averaged 1.8% over 2019, down from 2.5% in 2018 and 2.7% in 2017.

“At 1.8% in January, consumer price inflation was still below the Bank of England’s 2.0% target rate.

“Some rise in inflation in January had been expected due to unfavourable base effects – inflation had fallen particularly sharply in January 2019 when Ofgem’s cap on consumer energy prices came into effect. However, it was also lifted by higher petrol prices and a smaller-than-usual drop in airfares after the usual spike up in December for the holidays 

Further upward pressure on inflation in January came from clothing and footwear prices, and restaurants and hotels.

“Core inflation rose to 1.6% in January after dipping to 1.4% in December (the lowest since November 2016) from 1.7% in November, October and September. Core inflation had previously risen back up to 1.7% in September after dipping to 1.5% in August from a six-month high of 1.9% in July (when it had been lifted by price hikes for some of the more erratic components, notably consumer games and consoles). Core inflation had previously been locked in a very narrow 1.7-1.8% range from February through to June. 

Outlook for inflation

“We suspect inflation could move back down in February. Some of January’s rise was due to prices for airfares, hotels and restaurants and clothing and footwear falling back less than usual in January, and that could unwind in February. Also, oil prices have fallen back markedly overall so far in February compared to January. Brent oil is currently trading around $58/barrel compared to around $65/barrel in late-January.

“Additionally, inflation should be helped  in the second quarter from lower energy price inflation from April (when the April 2019 increase in Ofgem’s electricity and gas price caps will drop out of the year-on-year comparison). Additionally, Ofwat has proposed lower water and sewerage price caps from April. Meanwhile, the pound’s overall strengthening in recent months should feed through to have some downward impact on inflation.

“Consequently, we believe inflation is likely to get back to below 1.5% in the second quarter and possibly get as low as 1.3% in the third quarter. Inflation is seen as starting to trend gradually upwards during the latter months of 2020, but it looks unlikely to reach the Bank of England’s 2.0% target rate. We see inflation ending 2020 around 1.7%.

“Domestic inflationary pressures are expected to be limited over the next few months at least, due to spare capacity following recent below-trend UK growth, which is likely to constrain companies’ pricing power. Meanwhile, annual earnings growth has come down to 2.9% in the three months to December from an 11-year high of 3.9% in the three months to July 2019. While this partly reflected lower bonus payments, it is notable that annual regular earnings growth has come down to 3.2% from 3.9% (earnings growth of 4.0%–4.5% used to be considered consistent with the Bank’s target inflation rate of 2.0%). We suspect that earnings growth is likely to stabilise around or just under 3.5%.

“Price pressures further down the price chain picked up in January but were still relatively contained overall and do not look alarming for consumer price inflation. Producer input prices rose 2.1% year-on-year as they rose 0.9% month-on-month (largely due to a spike in the price of imported metals). Meanwhile, the annual increase in producer output prices was still relatively limited although it rose to 1.1% from 0.9% in December as they rose 0.3% month-on-month.

“Consumer price inflation is expected to be  modestly firmer in 2021, reaching 2.0% by mid-year and possibly ending the year just above 2%. This is expected to be the consequence of stronger growth and an improved labour market. Brent oil is seen averaging $65/barrel over 2021, up from an expected $62.3/barrel over 2020.”