Will CPI inflation fall below 5% by the end of 2023?

Headline inflation took a sharp plunge last week. But the devil is in the details – while the consumer price index’s inflation measure is now on a downward trajectory, core inflation is rising.

This means we are likely to see even more rate hikes from the Bank of England in the coming months, even as energy and petrol prices fall rapidly.

We look at why inflation in Britain is stubbornly high, what’s driving core inflation and whether the CPI is on track to fall below 5% by the end of the year.

Why is core inflation rising?

The CPI, which tracks the price of a basket of goods, peaked at 11.1 percent in October.

It has since fallen back – but at a slower pace than economists and markets expected.

In April, however, the CPI fell sharply from 10.1% in March to 8.7%, suggesting that the Bank of England’s strategy is finally paying off.

A closer look at the numbers and an increase in core inflation – excluding energy, food, alcohol and tobacco – from 6.2 percent to 6.8 percent suggests that there is more underlying inflationary pressure than expected.

Core inflation excludes anything that is volatile and related to rapid price falls once the price of commodities falls.

This is what economists call “sticky” inflation – it’s more persistent and you’re less likely to see massive volatility.

This has risen much more than expected to the highest level in 30 years.

So what is driving inflation higher? One of the reasons could be that the price of services is rising.

The April figures show that the price of goods fell from 12.8 percent to 10 percent, but that of services rose from 6.6 percent to 6.9 percent.

Capital Economics said: “The latest data show that inflation is increasingly being driven by rapid wage growth reflected in domestic services prices.”

Samuel Tombs, UK chief economist at Pantheon Macroeconomics, said the reduction in government energy price subsidies to businesses may also have forced some services to raise prices to stay afloat.

April’s higher figures may also have something to do with the start of the tax year with council tax increases, social rents and phone and broadband bills trickling through.

ONS figures show that the price of communications had risen significantly, most of which can be attributed to price increases by mobile phone companies.

The ‘stickiness’ of core goods CPI is because ‘the UK’s non-food retailers absorbed much of last year’s rise in core producer prices’, Tombs said.

“It is therefore not surprising that they have increased prices rapidly in recent months, despite the stabilization of producer prices.”

This is good news for consumers as it means that the price of core goods is likely to fall in the coming months.

Although food prices are not part of the core basket of goods, they also remain stubbornly high, falling just 0.1 percentage point to 19 percent in April.

Tombs said: “The persistence of food CPI inflation came as a big surprise as the rate of increase in producer production prices has slowed sharply this year and price increases for eurozone consumers have slowed.

In theory, the recent decision by some supermarkets to offer discounted prices to customers with loyalty cards could have driven up food CPI inflation, if they financed these discounts by raising prices for regular customers more than producer prices warrant. .’

> Read if and when food prices will return to normal levels

When will inflation in the UK start to fall?

Inflation in Britain has continued to rise and has remained elevated more than anywhere else in Europe as it recovers from the double whammy of an energy shock and labor shortages.

Energy prices are already starting to become a downward driver for the CPI – in April it fell by 1.8 percentage points and will fall further in July when the energy price cap falls to around £2,000.

However, even with falling energy prices, broader economic conditions may cause inflation to persist for some time.

“The tighter labor market is likely to lead to core inflation in the UK remaining higher than in the US and the eurozone through the end of 2024,” said Ruth Gregory, UK deputy chief economist at Capital Economics.

In his annual report, Bank of England Governor Andrew Bailey said: ‘While we expect CPI inflation to fall quite sharply as energy costs start to fall, albeit at a slightly slower pace than expected in February given the outlook for food prices in the near term, the outlook for inflation further down the road is more uncertain and depends on the degree of persistence in wage and price-setting.”

It is now much more likely that the central bank will have to keep raising rates in the coming months and markets have priced in the base rate to 5.25 percent.

The puzzle for the bank is whether core inflation will continue to rise, and economists seem undecided about when and how this will stop.

Uncertainty around the core remains, pointing to the risk of persistence,” said Modupe Adegbom G7 economist at AXA Investment Managers.

“Some elements were expected to drive the core higher, including increases in phone and broadband bills, but the magnitude of the increase will worry the MPC, especially relative to their already high inflation expectations.”

It’s not all doom and gloom, however, as inflation is expected to fall in the coming months.

Pantheon Macroeconomics predicts that it is “a matter of time before households take full advantage of the recent slowdown in producer output prices.”

Services inflation is likely to fall and core goods prices are likely to fall at the same time. The ONS’ Business Insights and Conditions Survey found that only 24 percent of retailers plan to raise prices next month, below the 12-month average of 37 percent.

The survey also shows that only 30 percent of accommodation and service companies plan to raise prices in June, which is lower than the average of 42 percent in the previous 12 months.

Pantheon Macroeconomics now forecasts headline inflation to fall to between 4 and 4.5 percent by the end of the year and to 2.2 percent in April next year.

There could be more domestic shocks and a further escalation of the war in Ukraine that could put pressure on this forecast, but a large wave of economists seems increasingly convinced that the CPI will fall in 2023 – and possibly below that 5 percent level. Rishi Sunak was aiming for one of his five priorities at the start of the year.