Press release

20 Jan 2021 London, GB

Consumer price inflation up to 0.6% in December and looks set to trend upwards modestly in 2021 – EY ITEM Club comments

Consumer price inflation rose slightly more than expected to a still-limited 0.6% in December from a three-month low of 0.3% in November

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Related topics Growth COVID-19
  • Consumer price inflation rose slightly more than expected to a still-limited 0.6% in December from a three-month low of 0.3% in November
  • December's inflation was still not far above the August’s 2020 low of 0.2%, which had been the lowest level since January 2016
  • Low inflation is supportive to consumers' purchasing power amid rising unemployment and the prospect of limited pay increases
  • Inflation was primarily lifted in December by clothing prices, which did not follow normal seasonal patterns in 2020 due to the impact of COVID-19. Upward pressure also came from transport costs and petrol prices as well as from recreation & culture prices
  • However, inflation continues to be limited by the temporary VAT cut for the hospitality and leisure sectors. There was also a dampening impact in December from food prices
  • Core inflation rose back up to 1.4% in December after dipping to 1.1% in November from 1.5% in October
  • There was evidence of a modest pick-up in price pressures further down the supply chain in December although they were still relatively limited. Producer input prices edged up just 0.2% year-on-year (y/y) in December after a fall of 0.3% in November as they rose 0.8% month-on-month (m/m). Meanwhile, the y/y fall in producer output prices narrowed to 0.4% in December from 0.6% in November as they rose 0.3% m/m
  • The EY ITEM Club expects consumer price inflation to hover close to 0.5% during early-2021 before starting to trend up gradually from Q2. Price conscious consumers, excess capacity, limited earnings and curtailed economic activity are likely to limit inflation in the near term at least
  • Inflation will rise once the temporary VAT cut for the hospitality and leisure sectors ends in March. Unfavourable base effects resulting from the fall in oil prices in early 2020 will also have an upward impact. After a challenging Q1, an expected progressive firming of the economic  recovery from early-2021 will also have some upward impact on inflation, but it is unlikely to rise quickly and may be just above 2.0% by the end of 2021
  • With inflation substantially below its 2% target in December, the Bank of England is likely to take further stimulus action to support the UK economy if necessary.

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

“Consumer price inflation rose slightly more than expected to 0 6% in December after dipping to a three-month low of 0.3% in November from a three-month high of 0.7% in October. “This meant that consumer price inflation averaged 0.9% over 2020, down from 1.8% in 2019 and 2.5% in 2018.

“December's inflation was still only modestly above the August low of 0.2%, which had been the weakest consumer price inflation level since January 2016. The consensus expectation had been for inflation to rise to 0.5% in December.

“Inflation was primarily lifted in December by clothing prices, which did not follow normal seasonal patterns in 2020 due to the impact of COVID-19. Upward pressure on inflation also came from transport costs and petrol prices, as well as from recreation & culture prices.

“However, inflation continues to be limited by the temporary VAT cut for the hospitality and leisure sectors. There was also a dampening impact in December from food prices. Downward pressure on inflation in November also came from food prices and non-alcoholic beverage prices.

“Core inflation rose to 1.4% in December after dipping to 1.1% in November from 1.5% in October. It had been as low as 0.9% in August.

“At 0.6% in December, consumer price inflation was much more than one percentage point below the Bank of England’s 2.0% target rate.”

Measuring of inflation in December less affected by restrictions

Howard Archer continues: “The Office for National Statistics reported that “the number of CPIH items that were unavailable to UK consumers in December 2020 reduced to nine from 72 in November 2020. In total, these unavailable items had a downward contribution of 0.01 percentage points to the change in the CPIH 12-month inflation rate. Most imputed items made no overall contribution to the change in the rate, with all of their contributions being less than 0.01 percentage points in magnitude.””

Outlook for inflation

Howard Archer adds: “The EY ITEM Club expects consumer price inflation to hover close to 0.5% through the first quarter of 2021 before starting to trend up gradually. Price conscious consumers, excess capacity, limited earnings and curtailed economic activity are likely to limit inflation in the near term at least.

“The economy looks headed for clear contraction around 3-4% q/q in the first quarter amid lockdown, having likely essentially stagnated in the fourth quarter of last year. This will increase the excess spare capacity in the economy. Meanwhile, unemployment looks likely to continue to rise over the coming months, despite the extension of the furlough scheme to April. Along with limited earnings, this will constrain consumer spending. Limited earnings will also have a dampening impact on inflation.

“The EY ITEM Club expects inflation to start rising from the second quarter of 2021 as the temporary VAT cut for the hospitality and leisure sectors ends at the end of March. Unfavourable base effects resulting from the fall in oil prices in the early months of 2020 will also have an upward effect on inflation in the early months of 2021, while an expected progressive firming of the recovery from Q2 2020 will also likely have some upward impact. Despite these factors, inflation is unlikely to rise quickly and it may be just above 2.0% by the end of 2021.

“There was evidence of a modest pick-up in price pressures further down the supply chain in December although they were still pretty limited: producer input prices edged up just 0.2% year-on-year in December after a drop of 0.3% in November as they rose 0.8% month-on-month. Meanwhile, the year-on-year drop in producer output prices narrowed to 0.4% in December from 0.6% in November as they rose 0.3% month-on-month.”

Bank of England has ample scope for further monetary stimulus if MPC believes warranted

Howard Archer concludes: “With consumer price inflation substantially below its 2% target in December, the Bank of England will feel that ample scope remains for it to take further stimulus action to support the UK economy – if deemed necessary – over the coming months.

“The impact on the economy from lockdown measures magnifies the chances that the Bank of England will take further near-term stimulus action, including the possible introduction of negative interest rates.

“However, the EY ITEM Club does not think that the Monetary Policy Committee (MPC) will go down the negative interest rate route. It suspects that if the MPC does act, it will be to carry out more asset purchases in the near term. The EY ITEM Club believes that after the first quarter of 2021, there will be a diminishing need for further Bank of England stimulus as the economy progressively establishes a firm footing.”