No Significant Decline in Inflation Expected Before 2023

CPI rose to 9.4% in June, up from 9.1% in May. Despite a big drop out of 0.5% from June 2021 the increase in CPI inflation reflected the very high level of new inflation between May and June 2022 of 0.8%. Month on month Inflation remains well above the historic norms and we are starting to see the impact of war and sanctions on Food and Energy–consuming Transport. If new inflation continues at this high level, inflation will not drop significantly until 2023. The main contributors to the change in inflation were:

• Transport​​​​​      0.16%
• Food and Non-Alcoholic Beverages​​     0.13%
• Restaurants and Hotels​​             0.12%
• Clothing and Footwear ​ ​           – 0.06%

Other sectors made small increases or decreases which added up to the overall increase of 0.33% from 9.08% to 9.41%. (Headline inflation increased from 9.1 to 9.4% as (the ONS publishes inflation to one decimal place.))

Whilst the large increase in inflation in April was mainly driven by domestic energy prices, Food and Transport are the main drivers keeping inflation high in May. The increase in inflation is a mixed story which reflects the base effects from the previous year’s high inflation in May-June 2021.  The negative contributions to current inflation from Clothing & Footwear and Furniture & Household Equipment arise from the base effect of past increases dropping out.

This will be the story for the rest of 2022.  Month on month inflation was high for most months in 2021; as we move forward, to sustain or increase the headline inflation level, new inflation will need to come forward to replace that. If the new inflation in 2022 is higher than the old inflation dropping out from 2021, we will see an increase in inflation; if the new inflation is less we will see a decrease. The inflationary story for 2022 will be a tug of war between past inflation pulling down with the new inflation pulling up.

The future path of inflation depends crucially on how the war itself affects the world economy and more importantly the impact of sanctions imposed on Russia by the Western powers. The war and sanctions are having major effects on a range of commodities, includingwheat and other grains, fertiliser, various metals and of course energy. (See my March inflation blog for more details.)

All of these commodities will be affected to some extent and the ensuing restrictions on supply will be a major driver of inflation in the UK and around the world. Currently, sanctions have been imposed by the “Western powers”, the US, Canada, the EU, the UK and their close allies in the far East (Japan, South Korea, Australia, New Zealand, Singapore and Taiwan). The impact of sanctions on the UK economy will also depend on whether secondary sanctions are imposed on the many other countries around the world that continue to trade with Russia and how effective these secondary sanctions might be. The more effective the sanctions are, the greater the effect on world supply and hence on inflation. However, given that the EU continues to consume Russian energy it is unlikely that secondary sanctions will be a practical policy tool in the near future.  

The continuation of China’s zero covid policy is also having a major impact on the Chinese economy and global supply chains. The WHO has stated that this policy is not sustainable given the highly transmissible variants of Covid currently spreading around the world. However, there is little sign of the Chinese government altering its current policy soon and certainly not before the March 2023 conclusion of the Party congress and expected renewal of Xi Jinping’s Presidency. Whilst the continuing Covid lockdowns are unpopular, the number of covid deaths even from the current milder strains would still be very large given the population of China.

Turning back to the June inflation figures, we can look in more detail at the contributions of the different sectors to overall inflation, we can look at the old inflation dropping out of the annual figure (May-June 2021) and the new monthly inflation dropping in (May-June 2022) and use the expenditure weights to calculate CPI. In the chart below, we show the “dropping out” in blue and the “dropping in” in light brown. The overall effect is the sum of the two and is shown as the burgundy line.