Inflation slowed further than expected in January – EY ITEM Club comments

• Consumer Price Index (CPI) inflation continued to fall in January due to lower air fares, another significant fall in petrol prices, and strong base effects weighing on core inflation. The EY ITEM Club now thinks inflation could reach almost 3% by the end of the year, helped by a continued decline in wholesale energy prices.
• A cooling in services inflation emphasised that March's Monetary Policy Committee (MPC) decision is uncertain. And given the lower reading was heavily influenced by the volatile air fares category and base effects, whether the Bank of England will increase rates again next month is very much still in the balance.

Martin Beck, chief economic advisor to the EY ITEM Club, says: “Consumer Price Index (CPI) inflation surprised on the downside in January, falling to 10.1% from 10.5% in December. Around half of the fall in the annual rate – and the source of the downside surprise – was due to lower prices in the volatile air transport category. There was also a lower contribution from petrol than expected, with pump prices having fallen significantly for a second successive month in January. The remainder of the fall came from lower core inflation, although this was partly due to base effects following a large month-on-month increase in the previous January.

“Though January's soft reading was heavily influenced by temporary factors, the outlook for inflation in 2023 has continued to improve in recent weeks, with wholesale energy prices declining further. This should mean that the typical household energy bill falls to around £2,300 in July from £3,000 at present. Combined with powerful base effects, this would mean that the contribution of the energy sector to inflation would fall from its current 3.2ppts to zero in the latter part of this year. Though there will be some offsetting forces – including the continued pass through of higher energy and labour costs for businesses – the EY ITEM Club now expects CPI inflation to slow to as low as 3% by the end of the year.

“Today's data add to the uncertainty around whether the Bank of England will increase Bank Rate again in March. The Monetary Policy Committee (MPC) has expressed concerns about the strength of private sector regular pay growth and services inflation. While the former came in strongly again in yesterday's labour market release, the latter was much softer in today's data, falling to 6.0% in January from 6.8% in December. The fall in air fares and base effects played major roles in the lower reading, but the data emphasise that the positioning of the MPC for March's decision is still in the balance.”