It was nice while it lasted, but the days of ultra-low inflation are over – at least for the time being.
The year ahead is going to be marked by rising prices and squeezed living standards, but the pickup in the cost of living needs to be put in perspective; January’s increase was smaller than expected, and the result of prices falling less sharply than they did a year ago.
Also, the UK was spoiled by a couple of years in which crashing oil prices flattered the inflation figures. Some bounceback was always likely in late 2017, and the upward trend has been exacerbated by the decision of the Opec cartel to cut production.
Britain is not alone in seeing prices start to rise. Germany currently has slightly higher inflation (1.9%) than the UK (1.8%), suggesting that the upward move over the winter has more to do with commodity prices than the fall in the pound following the Brexit vote last June.
That interpretation is supported by the Office for National Statistics data for core inflation, which strips out the impact of energy, food, tobacco and alcohol. This stood at 1.4% last June and is now at 1.6%. Over the same period headline inflation – which includes all the above items – has risen from 0.5% to 1.8%.
There is some evidence that competition is helping to keep the lid on prices. Clothing and footwear retailers had a pretty tough January and reduced prices by more than they did in early 2016. Without those high street and online bargains, the annual inflation rate would have risen closer to the Bank of England’s 2% target.
That said, it looks unlikely that retailers will be able to defer price rises for ever. The separate ONS figures for producer prices – which measures how much manufacturers are paying for their fuel and raw material on the one hand and the cost of goods as they leave factory gates on the other – show a pronounced rise in the second half of 2016 and early 2017. Input prices are up by more than 20% year on year – the sharpest rise since oil prices were rocketing in 2008 – while factory gate prices are going up by 3.5% a year – the fastest rate since 2012.
Some of this pressure, clearly, is the result of higher global energy prices. The 16% drop against the dollar is also making imports more expensive and this will have more of a bearing on inflation as 2017 wears on.
Three conclusions can be drawn from all this. The first is that inflation is going to carry on climbing and will probably overtake the current rate of earnings growth within the next few months.
The second is that the Bank of England will not respond with an increase in interest rates unless there is evidence that the higher cost of living has set off a price-wage spiral.
But unless wages do start to rise, 2017 is going to be quite a tough year for consumers. The balance of the economy is likely to shift towards manufacturing and exporting, helped by the weak pound. That explains the third conclusion. Growth may not be that much weaker in 2017 than it was in 2016, but that is not the way it is going to feel to households.
German growth can help in Brexit talks
Germany will be crucial in the Brexit negotiations that will commence once Theresa May triggers the article 50 process next month. The prime minister’s confidence that a deal good for all parties can be negotiated depends to a large extent on Angela Merkel’s willingness to put the interests of German industry above the desire to use a punitive settlement to deter any other country that might be tempted to follow Britain’s lead.
The latest German growth figures are likely to foster rather than discourage such optimism among ministers in London. It was not that the expansion of the eurozone’s biggest economy in the fourth quarter of 2016 was slightly smaller than expected – 0.4% rather than 0.5% – and weaker than the UK’s 0.6%.
Rather, it was the breakdown of the growth, which was strongly dependent on domestic demand, and in particular higher government spending on refugees. Net trade, traditionally the motor of the German economy, subtracted from growth on the quarter because imports rose more strongly than exports.
In one respect, this is a helpful development since Germany has been running an excessively high current account surplus and needs to bring it down for the good of the rest of the eurozone and the global economy. But the economy’s future prospects are inextricably linked with the country’s big manufacturers and the medium-sized – Mittelstand – companies that sit beneath them.
With Donald Trump making protectionist noises, German exporters can already imagine the US market becoming more difficult during the course of 2017. They probably won’t welcome access to the UK being simultaneously jeopardised – a point May will no doubt be making to Merkel.
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