Insight

Inflation comes in below forecasts but the only way is up

ITV News Economics Editor Joel Hills reports on the latest inflation rate figures


Inflation is the rate at which prices change, not a measure of how high prices are.The Bank of England’s target is to ensure that Consumer Price inflation hovers around 2%, and in July that’s precisely where inflation was calculated to be by the Office for National Statistics (ONS).Discounting by clothing and footwear retailers and cheaper electronic goods helped push the annual rate of inflation down from 2.5% in June and was lower than economists expected but beware “base effects.” The next move is likely to be upwards.The ONS compared prices last month with prices in July last year - which in some cases were distorted by lockdown. The underlying picture is hard to see.

Credit: Pantheon Macro

There are several factors at play here:The lifting of restrictions since April has set off a boom in demand for things like cars, furniture and sporting goods, as households spend some of the savings they accumulated during lockdown. Meanwhile supply chains have been disrupted. The cost of shipping goods has exploded and a world shortage of semi-conductor chips has restricted car production (note: used car prices are an extraordinary 14% higher than a year ago).And while pubs, hotels and restaurants can’t move for customers, many find themselves short-staffed, for reasons that appear to concern Brexit as well as Covid. In some sectors it’s an employee's market, wages have risen as a result.The economic recovery is vigorous but “bumpy,” as the governor of the Bank of England put it last week. In places demand is running ahead of supply, elsewhere it’s the other way around and prices are moving accordingly.What happens next is, of course, unknowable and, unhelpfully, economists are pretty hopeless at forecasting inflation with any accuracy.

While pubs, hotels and restaurants can’t move for customers, many find themselves short-staffed. Credit: PA

For what it's worth though, the consensus is that price rises will pick-up pace again.Manufacturers report that their raw material costs remain high. Input prices hit 9.9% and output prices rose to 4.9%, suggesting that some of these increased costs are now being passed on to consumers.Gas and electricity prices will rise sharply from October due to the increase in the default tariff caps, announced by OFGEM earlier this month.The reduction in VAT to 5% for businesses in hospitality and tourism is due to disappear at the end of the month.

And there are early signs that where house prices blazed a trail, rent will follow.The Bank of England expects living standards to be squeezed in the months ahead, and forecasts that inflation will peak at 4% at the end of the year.It judges that this period of mismatched supply and demand will prove temporary, if painful for those on the lowest incomes. At the moment the evidence suggests that’s a safe bet, but keep a close eye on what’s happening in the labour market.“We’ve got a big increase in vacancies and it really is critical, from the point of view of inflation, that the jobs market works and those vacancies get filled,” Andrew Bailey told ITV News earlier this month.The concern is that staff-shortages could drive higher wages and inflation and force the Bank of England to raise interest rates sooner than it would do otherwise.