UK inflation drops to 3% due to falling transport costs

Marina Gerner
16 January 2018

Consumer Prices Index (CPI) inflation stood at 3% in the year to December 2017, down from 3.1% in November, according to the Office for National Statistics’ (ONS) latest figures.

Once a month, the ONS determines the price of a ‘shopping basket’ of goods and services typically bought by UK households. This is used to calculate the CPI measure of inflation.

In January last year, inflation stood at just 1.8%, but it had risen to 3.1% by November 2017.

December marks the first slight easing in inflation since June last year, but it still exceeds the Bank of England’s target of 2%.

The largest downward contribution came from transport, particularly air fares. The report states that as is usually the case in December, air fares rose sharply, but at a lower rate than in the previous year.

It’s important to understand that the ONS measures movements rather than price levels to gauge inflation. In other words, if the cost of flights goes up by 10% one year and it goes up by 8% the next year, then the ONS will record this as a downward movement – but in real terms your plane ticket is still getting more expensive.

“It remains too early to say whether today’s slight fall is the start of any longer-term reduction in the rate of inflation,” cautions James Tucker, an ONS statistician.

Ben Brettell, senior economist at Hargreaves Lansdown, says: “Inflation has been a hot topic since the Brexit vote caused a sharp drop in sterling 18 months ago. But logic has always dictated that once the effect of the weaker pound percolated into the real economy, it should then start to drop out of the year-on-year calculations 12 months later.

“It now seems likely we’ll see the rate steadily fall back towards the 2% target over the next year or so.”

Mr Brettell argues that if we strip out the Brexit noise, the UK’s underlying economic situation doesn’t look materially different from the rest of the developed world. “Big themes like an ageing demographic and the rise of disruptive technologies are exerting downward pressure on prices,” he notes.

Interest rate hikes ‘less likely’

Ed Hutchings, senior portfolio manager for UK Sovereigns at Aviva Investors, agrees that inflation is likely to begin to fall again, and suggests this makes further significant interest rate hikes less likely. “With the remaining uncertainty surrounding Brexit negotiations, and wage gains still very much subdued, the Bank of England is likely to continue to proceed cautiously when raising interest rates further.”

With the market now pricing in two 0.25% increases over the next two years, Mr Hutchings argues there are unlikely to be any large moves higher in the near term while Brexit uncertainty prevails.

Matthew Brittain, investment analyst at wealth manager Sanlam UK, adds: “More worrying from our point of view is the continuing stagnation of wages, with increases tending to be well below the rate of inflation. This means that disposable incomes are in decline, forcing people to reduce their savings or take on more debt to maintain their standard of living.”

Maike Currie, investment director for Personal Investing at Fidelity International, echoes this concern: “While price pressures may have eased slightly, this will be cold comfort to cash-strapped consumers who are still suffering a pay cut in real terms as inflation continues to outpace wage growth (including bonus) at around 2.5%.”

Persistently high inflation also holds implications for people’s savings, as inflation erodes the spending power of future interest payments and eats away at the worth of the original capital. 

This article first appeared on our sister website Money Observer.

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