Analysis: Threadneedle Street believes the above-target 2.1% figure will prove temporary
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Inflation is on the march. After the easing of lockdown in May, Britain has raced from economic bust to boom, with the rate of consumer price inflation hitting 2.1% – above expectations and breaching the Bank of England’s 2% target rate.
Driven by the rising cost of petrol, clothing and recreation in the month indoor hospitality reopened, the latest snapshot will fuel concern that the cost of living is spiralling out of control. But it must also be taken with a pinch of salt.
Inflation is measured using a basket of goods and services and taking the 12-month price change. Behind the headline rate are price movements heavily influenced by May 2020, when Covid-19 crippled the world economy.
Motor fuels were the biggest driver of the latest inflationary burst, rising by an eye-watering 17.9%. But wild price swings were to be expected. The Office for National Statistics notes average petrol prices stood at 127.2p a litre in May, compared with 106.2p a year ago when the UK was in the first national lockdown and the global oil price collapsed. It is worth noting that petrol prices are only 0.2% higher than in January 2020, before the coronavirus struck.
Clothing and footwear prices are also on the march but this again is in part down to relatively low prices a year ago. In stark contrast, the price of food on supermarket shelves is falling.
It is for this reason that many economists are sceptical that the UK is entering a new era of sustained higher inflation. The Bank of England agrees, reckoning that above-target inflation will prove temporary. It is willing to tolerate it for a time and won’t raise interest rates or wind down its quantitative-easing bond-buying programme until there is more evidence of progress in the economy.
However, the Bank had anticipated its inflation target would be breached at a much later point this year. Pressure will build on Threadneedle Street not to fall behind the curve. The meeting of its rate-setting monetary policy committee on 24 June will be closely watched – especially as it is the last for the Bank’s chief economist, Andy Haldane, a chief hawk who has warned of the growing dangers from inflation.
The big question is whether more chronic inflationary pressures will emerge. There are some signs this could be the case, as companies report staff shortages and problems with the rising price of raw materials and transport costs – exacerbated by Covid-19 border restrictions and Brexit.
Factory gate prices rose 4.6% on the year, as the cost of materials surged 10.7% for Britain’s manufacturers, led by metal prices soaring to the highest point since May 2007. This could feed through to higher prices in the shops, if retailers pass these price rises on.
At this stage, however, it is too early to tell for sure. Many economists warn the bigger danger would be acting too early to prick an inflationary bubble that may dissipate of its own accord, threatening to derail the recovery. With a delay to the further easing of pandemic restrictions, risks to the economy still remain.
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