On the surface, UK inflation in 2023 is becoming similar to the problem in the 1970s, when people talked about a “British disease” making the country the “sick man” of Europe.
Stubbornly high inflation that eclipses rates in other countries. Index-linked contracts amplifying price pressures. The authorities struggling to control household costs. And wages following prices higher.
Wednesday’s figures — which showed April inflation of 8.7 per cent, far above the 8.4 per cent expected by the Bank of England — underlined that Britain appears to have a particular problem.
The country is feeling both the impact of robust government spending at a time when labour markets are tight — also a problem for the US — and the residual effects of a huge rise in European wholesale gas prices last year.
But, with UK inflation significantly higher than in almost all other countries in western Europe and the BoE making repeatedly over-optimistic predictions, the excuses are wearing thin.
Stephen King, senior economic adviser to HSBC and author of We Need to Talk about Inflation, was scathing following the release of Wednesday’s figures by the Office for National Statistics.
“It doesn’t look good, does it?” King said. “Depressed growth, not helped by Brexit. Real wage resistance. Core inflation the highest in decades. The BoE admitting it’s been using a model that hasn’t worked well of late. Policy rates still very low relative to 6.8 per cent core inflation . . . oh dear.”
UK inflation is now much higher than the eurozone average of 7 per cent. The only other two western European countries with rates of above 8 per cent are Italy — where inflation is the same as the UK — and Austria. Food prices are still soaring at a 19.1 per cent rate in April.
Adding to the sense that the UK is out on a limb, the London School of Economics on Wednesday published new research showing that Brexit trade barriers had contributed 8 percentage points of the 25 per cent rise in food prices between 2019 and March 2023.
For three consecutive months, the BoE has also been caught out, failing to understand the short-term dynamics in prices. In February, the central bank expected inflation to fall to 9.2 per cent by March but it remained at 10.1 per cent.
When the BoE revised its forecasts this month, it built in new margins for error to improve accuracy. Privately, officials said the central bank had tried everything to ensure the forecasts were not again too optimistic.
BoE governor Andrew Bailey conceded on Tuesday that the bank had “very big lessons to learn” on controlling inflation and its forecasting.
He said the failure to understand immediate price pressures in food were partly the result of adverse weather in Morocco that the BoE could not have predicted and had affected supply chains for perishable items such as cucumbers and tomatoes.
But Bailey also accepted that the BoE had not realised that food manufacturers had locked in long-term wholesale contracts on food global commodity prices, which were close to their peak of last year.
It is clear the governor also did not see the latest month’s 1.2 per cent rise in UK prices coming. Nor did he expect price rises to be as broad, driven higher by increased costs of second-hand cars and large rises in mobile phone charges, as well as books, sports and gardening equipment and pets products.
The increase in mobile phone charges was partly due to index-linked contracts, a feature of life in the 1970s and still a reason why inflation lingers today.
Even before the latest forecast errors, BoE officials had been under pressure to explain themselves to MPs at the House of Commons’ Treasury committee on Tuesday.
Although Bailey said the bank had already used its judgment to push its forecasts higher, he was criticised by Harriett Baldwin, the committee chair, for using a model solely based on data that reflected 30 years of relative price stability.
Huw Pill, BoE chief economist, said the central bank was studying historic data carefully for insight into how to control inflation. “We do think about [whether] we should be using models or revisiting frameworks that were applied to the data of the 1970s and 1980s,” he said.
“But crucially, while there may be something to learn from that, there are also reasons to think that experience is not immediately relevant,” Pill added.
Inflation remained persistent in those decades, Pill said, because companies and employees began to expect inflation would remain at high levels, and set prices and demanded wage increases accordingly.
Even though Bailey has accepted that a wage-price spiral is amplifying inflation, his chief economist said the current situation was different to the 1970s.
“The structure of the labour market is very different . . . and in particular the regime in which monetary policy is conducted is very different,” Pill said.
The BoE has stressed that most of the inflation has come from sharp rises in the price of gas and food, which the UK imports and the central bank has no control over.
As economists pointed out on Wednesday, the problem with the BoE blaming inflation on imported energy and food prices is that it is becoming increasingly inconsistent with the data.
Core inflation jumped from 6.2 per cent in March to 6.8 per cent in April when the average of economists’ expectations predicted it would remain constant.
Official figures also showed that the goods and services that contained few imported elements were adding increasingly to the overall inflation rate.
The ONS said that in April, items that had less than a 10 per cent import intensity, such as housing rents, contributed 1.76 percentage points to the 8.7 per cent inflation rate. This was up from 1.38 percentage points in March and the highest level since the series was first published in 2006.
Allan Monks, UK economist at JPMorgan, said this was alarming and would prompt the BoE to raise interest rates further.
“[The data] cannot be described as a one-off or simply as an indirect byproduct of food and energy price gains, as the BoE and the doves have tended to suggest up until very recently,” Monks said.
The echo of times past spooked financial markets on Wednesday, sending expectations of future interest rates sharply higher. Financial markets predict rates will rise to 5.3 per cent by the end of the year.
This might be over-egging the problem, according to Sandra Horsfield, UK economist at Investec, who expects another quarter-point rise to 4.75 per cent in June.
In a time of 1970s-style stagflation, with little growth and high inflation, she said: “Little can be ruled out, but it is questionable that slamming that much harder on the brakes is necessary.”