Inflation jumps to highest level since May
With price rises expected to hit 3pc in coming months, householders will need to dig deep for some time yet, reports Tim Wallace
PRICE rises accelerated in August as costs for clothes, shoes, furniture and telephones all picked up pace.
Inflation hit 2.9pc, the Office for National Statistics said, up from 2.6pc in the 12 months to July and the highest level since May, indicating that the fall back in price pressures in June and July may have been a blip in the upward trend.
The weak pound has pushed up import prices and that has fed through into costs for shoppers, hitting households in the pocket.
Prices for clothes and shoes rose by 4.6pc on the year, the fastest pace in almost 30 years. Trips to restaurants and hotels also became 3.5pc more expensive compared with August 2016.
However, food inflation slowed down, dipping from 2.6pc in July to 2.1pc in August, reducing the intensity of the pressure on the weekly shop.
Households are under increasing strain – the latest pay numbers show earnings rose by 2.1pc in the year to June, with prices rising at a faster pace. “Inflation resumed its ascent as the Brexit-induced fall in sterling continued to push up the cost of living for families,” said Richard Lim at Retail Economics.
“With wage growth remaining disappointingly sluggish, rising prices across food, clothing, energy and transport have intensified the pressure on personal finances. Households will continue to transition to a period of lower levels of spending power over the coming months, which will put further pressure on consumer spending.”
Economists expect inflation will peak at more than 3pc later this year before starting to fall back again.
Clothes are more expensive. Women are suffering runaway inflation in the shoe department. Coffee prices are boiling over. After a welcome spell of falling prices and intense competition between shops, British households are feeling a wave of inflation.
Price rises are not dramatic by historical standards – at 2.9pc consumer price inflation is nowhere close to its 2011 levels of more than 5pc – but costs are outstripping wage growth which makes for an uncomfortable time when working through the household finances.
Economists expect inflation to peak at a little over 3pc before falling back once more. But it might not be that simple.
The food sector appears to have undergone a serious shift in attitudes.
Currency markets have pushed inflation up in the past year, but the worst might not be over yet.
And pay growth is not picking up despite record low unemployment.
The weekly shop
Supermarkets have changed their pricing systems to adapt to the squeeze.
For several years the big grocers were engaged in a fierce price war, chopping costs and offering eyecatching discounts and promotions to lure shoppers through the door.
But there is only so far that strategy can run as margins are eroded. Now that the cost of imported goods – from tropical fruits and foreign-raised animals to imported clothes and household equipment – is on the rise, shops have to work out how to preserve their profits.
Shoppers have become increasingly savvy in recent years, keeping their eyes peeled for a good deal.
That means they also spot price rises, which puts the grocers in a difficult position.
“There is only so far that retailers can eat into margins before they get into trouble, and a lot of them have reached that point where they have no real alternative but to put up prices,” says Toby Clark at Mintel.
“In groceries, everyday prices have not changed as much as headline inflation, but there is less discounting. It is a way to protect margins without putting through across-the-board price rises – discounts and promotions are much more sporadic now, so this is less noticeable than a rise in prices.”
The slippery sterling effect
The impact of the weak pound also has further to run.
Sterling did not just fall on the Brexit vote – the pound was dropping throughout the first half of last year.
Since the referendum it has also dipped further as the eurozone economies have gathered steam, pushing the euro up and so the pound down. On top of that, moves in the exchange rate do not affect shop prices instantly.
Companies can try to absorb the cost or delay passing it on, while some well-prepared firms had currency hedges in place to protect themselves against an unexpected slump in sterling. Most of those pre-referendum hedges have now expired, so those shops have got to make difficult choices on how to cover the higher import costs.
Economist Philip Shaw at Investec estimates that around 35pc of the exchange rate movement is passed on to changes in prices – as not every item on the shelves is imported – and that just over half of that change in prices takes place in the first year after a currency move. This would indicate that almost half of the fall in the pound since the Brexit vote is still to hit consumer prices, and there could be a longer tail effect as the currency fell further on Theresa May’s Conservative Party conference speech last autumn.
That said, the pound does not move in isolation. The euro has risen strongly but could fall back a little in coming months, for example, which would push sterling up once more and take the edge off the rise in imported inflation. Mr Shaw predicts a slow decline in inflation, rising to above 3pc in the coming months before falling to 2.3pc by December 2018 and 2pc over 2019 as a whole.
Domestic price pressures
There is also domestically generated inflation to consider – not everything relates to the exchange rate. Economists at Nomura have built an index by compiling the 30pc of prices which are least correlated with the pound. This domestically generated inflation index stood at 1.7pc a year ago but has risen to 2.5pc, indicating growing price pressures regardless of the changes in sterling. George Buckley at Nomura says this indicates the economy is running at close to full capacity, suggesting these inflationary pressures will not disappear.
Producer price figures from the ONS also hint at this. Factory gate prices rose 3.6pc in August after inflation dipped in previous months, indicating companies might start to charge more for their goods.
At the same time one feature traditionally associated with an economy operating at full capacity is conspicuous by its absence: pay rises.
Unemployment is at the lowest level seen in more than 40 years, conditions which normally force companies to pay more to attract and retain workers. Yet there is little sign of this now and economists do not expect a recovery – even in 2018 economists predict pay will rise by 2.6pc and prices by 2.5pc, a meagre rate of real pay growth which will not overturn this year’s decline.
Inflation might be close to its peak, but that does not mean price rises will simply drop away. A steady grind of rising prices and stagnant pay looks more likely than any dramatic crunch and rebound in living standards.
A billboard for H&M on London’s Oxford Street. Shoppers have seen clothes prices across the UK rise sharply in recent months