What Does Today’s Smaller Than Expected Fall in Inflation Mean?

Annual CPI Inflation was 2.3 per cent in April 2024, down from 3.2 per cent in March.  This was largely driven by the high monthly figure from March 2023 of 1.21 per cent dropping out and the new inflation for March 2024 coming in at 0.3 per cent on the month, yielding the overall fall of a 0.9 percentage points in the headline figure. The month-on-month rate of 0.3 per cent is equivalent to an annualized inflation rate of over 3.6 per cent and was impacted by the fall in the Ofgem price cap reduction which led many to expect a smaller figure, or even a negative one. Without the Ofgem reduction which contributed about -0.3 percentage points, inflation would have been much higher. This suggests that inflation in the wider economy has not gone away, particularly after the high month-on-month inflation for February and March which both came in at 0.6 per cent (equivalent to annualized inflation in excess of 7 per cent).  If we net out the effect of the Ofgem price cap reduction, the month-on-month inflation in April would have also been around 0.6 per cent and the resultant headline closer to 2.6 per cent.

Measures of underlying inflation are a better guide to the longer-term outlook, and these are falling now: annual CPI inflation in services is slightly down to 5.9 per cent from 6.0 per cent in the previous month and core CPI (excluding Food and Energy) inflation is down to 3.7 per cent from the previous month’s 4.2 per cent.  NIESR’s trimmed mean measure of core inflation is also down to 2.5 per cent from 3.7 per cent in March. Furthermore, the latest wage data covering January to March 2024 came in at 6 per cent, confirming that persistence in pay growth pressures that may continue to keep services inflation high.  Indeed, the current inflation is a story of high service inflation combined with low or negative goods price inflation (annual goods price inflation was -0.8 percent in the year to April 2024).

The fall in inflation was reflected across most sectors, with the biggest contributors being:

Husing and Household Services                -0.45 percentage points

Alcohol and Tobacco                                   -0.16 percentage points

Food and Non-alcoholic beverages          -0.14 percentage points

Recreation and Culture                               -0.12 percentage points

Communication                                           -0.08 percentage points

The main exceptions were small increases in:

Restaurants and Hotels                              0.03 percentage points

Misc Goods and Services                            0.02 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 (March-April 2023) shown in blue and the new monthly inflation dropping in (March-April 2024) shown in brown.  The overall effect is the sum of the two and is shown as the burgundy line.

We can see our old story of the ‘Blue team’ pulling inflation down across almost all sectors as last year’s high figures drop out, whilst the ‘Brown team’ is positive in most sectors, with the big exception being Housing and Household services which includes domestic energy. Here the size of the Ofgem price-cap reduction impact comes in at -0.3 per cent. So, the overall month-on-month figure of 0.3 per cent is coming from all sectors, with big contributions in Transport (0.24 pp), Communications (0.11 pp) and Restaurants and Hotels (0.1 pp). Food and Non-Alcoholic beverages prices continue to increase, contributing 0.04 pp to the new inflation.

Extreme Items.

Out of over 700 types of goods and services sampled by the ONS, there is a great diversity in how their prices behave.  Each month some go up, and some go down.  Looking at the extremes, for this month, the top ten items with the highest monthly inflation are:

March was not a good month golfing or those wishing to keep cool.

The ten items with the highest negative inflation this month are shown in Table 2.

April was a great month for electricity and gas (courtesy Ofgem), as well as a nice pair of smart speakers to listen and sing along to your favourite operatic excerpts.

In both these tables we look at how much the item price-index for this month has increased since the previous month, expressed as a percentage.  These calculations were made by my former PhD student at Cardiff University, Dr Yang Li who has since returned to Shanghai.

Looking forward to April 2025.

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 “low inflation” scenario but have reintroduced it in response to some recent months with near zero month-on-month inflation.  We have also dropped the “High inflation persistence” scenario as it now looks unlikely unless geopolitical factors deteriorate significantly. We depict the following scenarios for future inflation dropping in:

• The “low” scenario assumes inflation each month is equivalent to 1 per cent per annum (0.08 per cent pcm).
• 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). This is now the central forecast.
• 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).

Previously we have followed the “very high” or “high” scenarios. We still think that the new figures are likely to come in on average somewhere between the two in the coming months.

The latest ONS data (covering the three months to March 2024) suggest that wages are growing at 6 per cent (excluding bonuses). That is, wage growth remains high as wages continue to catch up with past inflation. We can expect this to continue and put upward pressure on prices, particularly in the service sector. The inflation rate in services remains high at 5.9 per cent but is falling, whilst core inflation (excluding food and energy) has dropped to 3.9 per cent. These factors indicate that inflationary pressures are likely to persist well into 2024. However, the dropping out of the high inflation rates from 2023 will tend to dominate and drive down headline inflation for the first half of 2024 despite these persistent inflationary pressures. On a more optimistic note, today’s NIESR trimmed mean inflation measure has fallen significantly to 2.5 per cent.

The fact that the new inflation was high despite the Ofgem effect has raised our forecast for inflation as we move forward compared to last-months expectations.  We still believe the most likely outcome lies between the high and very-high scenarios, and this means that inflation in May will be 1.8-2.1 per cent where it will bottom out before creeping up again.  If we follow the high and very high scenarios, inflation will be in the range of 3-4 per cent by December 2024 with a clear upward trajectory through 2024. However, if month-on-month inflation comes in with low or medium figures, the range will be of 1.6-2.3 per cent by December, which shows inflation has stabilised around target.

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.  The Middle East remains a potential source of uncertainty, although the recent exchanges in April between Israel and Iran do not seem to have escalated as of now.

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.

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.