Inflation Anticipated to Fall in October with Loss of Ofgem Price Cap

Post Date
20 September, 2023
Reading Time
6 min read

CPI Inflation was 6.7 per cent in August, down slightly from 6.8 per cent in July.  Month on month inflation for July-August 2023 came in at 0.34 per cent (which is an annualized rate of 4.1 per cent) whilst the old inflation from July-August 2022 of 0.5 per cent dropped out, giving an overall fall of 0.16 per cent which after rounding gives the fall of 0.1 per cent in the headline rate. Inflationary pressures remain spread across most sectors and rates are well above the levels needed for the Bank of England to meet its target.  Inflation will remain high until a big fall to 5 per cent or below in October when the Ofgem price-cap increase of 2022 drops out.

The big contributors to the change in inflation were:

Transport  0.22 percentage points
Restaurants and Hotels -0.15 percentage points
Food and Non-Alcoholic Beverages -0.13 percentage points
Furniture and HH goods -0.09 percentage points
Recreation and Culture -0.09 percentage points

We can look in more detail at the contributions of the different sectors to overall inflation in Figure 2, with the old inflation dropping out of the annual figure (July-August 2022) shown in blue and the new monthly inflation dropping in (July-August 2023) shown in Brown, using the expenditure weights to calculate CPI.  The overall effect is the sum of the two and is shown as the burgundy line.

We can see that across different types of expenditure there is a mixture of stories, but in most cases the dropouts and drop-ins are pulling in different directions, with the blue dropouts pulling inflation down and the brown drop-ins pulling it up. The two big exceptions where the blue and the brown work together are Transport, where there is a very large drop-out pushing inflation up and Restaurants and Hotels where both new and old work to reduce inflation.

The fact that there is positive inflation across 9 out of 12 sectors in July-August, and only negative inflation in 1 sector (with the other two at zero) indicates that inflationary pressures are widespread.

Looking Ahead

We can look ahead over the next 12 months to see how inflation might evolve as the recent inflation “drops out” as we move forward month by month.  Each month, the new inflation enters the annual figure and the old inflation from the same month in the previous year “drops out”.[1]  Previously we ended the “Sanctions scenario” introduced in March 2022 in response to the invasion of Ukraine by Russia. However, since the new month on month inflation became high again in Feb-May 2023, we have re-introduced the Sanctions scenario, but renamed it the “high persistence” scenario since the causes have little to do with war and sanctions but rather domestic wage-price dynamics. We depict the following scenarios for future inflation dropping in:

  • The “medium” scenario assumes that the new inflation each month is equivalent to what would give us 2 per cent per annum or 0.17 per cent per calendar month (pcm) – which is both the Bank of England’s target and the long-run average for the last 25 years.
  • The “high” scenario assumes that the new inflation each month is equivalent to 3 per cent per annum (0.25 per cent pcm).
  • The “very high” scenario assumes that the new inflation each month is equivalent to 5 per cent per annum (0.4 per cent pcm). This reflects the inflationary experience of the United Kingdom in 1988-1992 (when mean monthly inflation was 0.45 per cent).
  • The “high persistence” scenario assumes new month on month inflation of 0.6 per cent, which is equivalent to an annual rate of 7.4 per cent.

Our central forecast is the “very high scenario”. However, as inflationary pressures are persisting, we believe that inflation will be in the range between this and the “high persistence” scenario (most uncertainty seems to be on the upside). The high figures for wage growth published by the ONS on September 12th indicate that annual wage inflation (excluding bonuses) is running at 7.8 per cent, which will put upwards pressure on service-sector inflation moving forwards and is likely to make aggregate inflation fall more slowly. However, when the “new inflation” starts to come down, we can shift our central scenario to the “high” and eventually the “medium” scenario. This may take some time, as discussed in When will UK inflation return to the Bank of England’s target of 2% a year? (Huw Dixon, Economics Observatory).

Whilst food price inflation seems to be falling (although price levels will remain high), the prospects for food price inflation have deteriorated following the decision of Russia to withdraw from the Black Sea grain agreement brokered by Turkey and the United Nations last year to facilitate exports of grain and fertiliser from Ukraine and Russia through the Black Sea.  This has already led to an increase in Wheat prices which will feed through to food prices in the shops in due course if not resolved.

The fall of the OFGEM energy price-cap back in July 2023 to its level in April 2022 (just over £2,000) played a major effect in reducing current inflation, reflecting the fall in energy prices from their peak last year. However, energy prices are unlikely to fall further and may rise again if the winter is cold. Liquified Natural Gas (LNG) is significantly more expensive than the piped gas which it has replaced, and we are not going back to the levels of domestic energy prices enjoyed prior to 2021, when the price cap was around £1,000 for a typical household. The OFGEM price-cap for October 2022 will fall very slightly from £2,074 to £1,923 for a typical household, which will have no significant effect on inflation.  Fuel and Lubricants saw an increase in prices in August reversing the fall since May 2023, but are still far less than prices in mid-2022 and early 2023.

This forecast assumes that geopolitical tensions do not deteriorate.  Direct conflict between Russia and NATO would rapidly worsen the picture for inflation.  Looking east, if the rising tensions between the United States and China lead to an intensification of the trade war or even open military conflict in the South China Sea or Republic of China (Taiwan), world supply chains would be disrupted, and inflation significantly raised, to levels far higher than seen in 2022.

For further analysis of current and future prospects for inflation in the UK see:

NIESR CPI Tracker

When will UK inflation return to the Bank of England’s target of 2 per cent a year? Economics Observatory.

How does Inflation affect the economy when interest rates are near zero? Economics Observatory.

How are rising energy prices affecting the UK economy? Economic Observatory.

NIESR Economic Outlook

[1] This analysis makes the approximation that the annual inflation rate equals the sum of the twelve month-on-month inflation rates.  This approximation ignores “compounding” and is only valid when the inflation rates are low.  In future releases I will add on the compounding effect to be more precise at the current high levels of inflation.