Has inflation peaked? We’ll find out on Tuesday. If the Bank of England was right to say last month that inflation peaked in October, we should see a slight fall in CPI inflation which should be the start of a steady decline.
Almost all economists agree with the Bank. This is because last year’s rise in import prices should soon fall out of the data, and most of the obvious usual causes of inflation are absent. For example:
- Wage inflation is lower than it was a year ago; next week’s figures should show it is around 2.3 per cent.
- Demand is slowing. Next week’s numbers should show that retail sales grew only 0.4 per cent in the last three months compared with the previous three.
- Inflation overseas is low. In the eurozone, core CPI inflation fell to just 1.1 per cent in November. This matters because there’s a strong correlation (of 0.6 since 2001) between eurozone and UK inflation rates.
- Monetary growth has slowed: the M4 money stock grew just 4.2 per cent in the year to October, an 18-month low. (In truth, most economists don’t think money matters much for inflation anyway.)
Where, then, might inflation come from?
One possibility is commodity prices: the GSCI index of these has risen 10 per cent since August. This, though, might not last. Purchasing managers report that business confidence in China has fallen, which is consistent with the fact that monetary growth – a good lead indicator of Chinese output – has slowed. This points to weakening demand for commodities soon.
The Bank of England, though, has a bigger worry. It fears the amount of spare capacity in the economy is small, and that this will put upward pressure upon inflation.
Herein, though, lies a puzzle. Much the same was true a year ago – the unemployment rate then was under 5 per cent – and yet wage growth hasn’t risen. (This isn’t a UK phenomenon: the same is true in the US.) Why, then, should it suddenly do so now?
It could be the case that there’s a sharp non-linearity in the link between unemployment and inflation so that 5 per cent unemployment is not inflationary whereas 4 per cent is strongly and swiftly so. Given that unemployment is at its lowest rate since 1975 we haven’t got the facts to rule this out.
There is, though, another possibility discussed in a speech earlier this year by Andy Haldane, the Bank’s chief economist. He suggested that a given level of unemployment today is associated with weaker workers’ bargaining power than in the past. This, he said, is because the workforce is more atomized now than before. Weaker unions, more part-time work and more temporary and zero hours contracts all mean that workers cannot parlay a tighter labour market into higher wages.
These are long-lasting developments, which point to wage growth staying low. And without wage growth, it’s hard to see much price inflation – unless sterling falls again or commodity prices do defy expectations and rise much more. It’s likely, therefore, that next year will indeed see inflation fall back towards its 2 per cent target.
