Inflation drops to 1.8% - its lowest level in two years

13 February 2019

Inflation has fallen to its lowest level since January 2017, offering welcome relief to cash-strapped households. 

The Consumer Price Index (CPI) measure of inflation was 1.8% in January 2019, down from 2.1% in December 2018. The alternative CPIH which includes housing costs was the same, at 1.8%.

This means inflation is now below the Bank of England’s target of 2% annual inflation. The Bank is unlikely to raise interest rates any time soon while inflation remains below target.

The Office for National Statistics (ONS) cited lower energy costs between December 2018 and January 2019 as the main contributing factor.

This could change however, as multiple large energy providers have announced price hikes in recent days.

Interest rates which rose twice in 2018 to quell rising levels of inflation, look set to be held as a result of the dip in inflation, and continued political uncertainty around Brexit.

Ben Brettell, senior economist, Hargreaves Lansdown says: “The chance of a UK interest rate rise was already galloping over the horizon, as Brexit uncertainty has put policymakers in a straitjacket lately. Today’s inflation figures provide further reason for the Bank of England’s rate-setting committee to sit on their hands.”

“In truth today’s numbers aren’t going to change the Bank of England’s thinking about the economy or interest rates. Assuming some kind of smooth Brexit, it should be able to gently nudge rates up over the next couple of years. Of course if we get a cliff-edge, no deal Brexit, all bets are off – a drop in sterling would likely see a sharp rise in imported inflation, but I’d expect the Bank to look through this and cut rates to support the economy.”

Labour market strength

Wage growth data released by the ONS on 22 January 2019 showed wages to be growing by a handsome 3.4%, well above the current level of inflation.

This means household income is now comfortably outstripping rising prices.

Kate Smith, head of pensions at Aegon, comments: “With the latest wage growth figures showing a positive trend, the gap between earnings and inflation continues to widen and households will feel an ease in the cost of living.

“In the period of real wage growth, individuals should find themselves in a strong financial position to set out financial goals and those who can afford to save any additional income should be encouraged to do so.”

But Mr Brettell notes a strange disconnect that has arisen in recent times between employment and wage figures and inflation: “From an economist’s perspective, an interesting thing to note about today’s numbers is the continued breakdown of the relationship between the labour market and inflation.

“Theory dictates that a tight labour market – low unemployment and higher wage growth – should lead to higher inflation. This means policymakers face a straight trade-off between inflation and unemployment.

"But at present the inflation genie is still firmly in the bottle, despite unemployment at multi-decade lows. This has made the Bank of England’s job much easier over the past few years.”

Alistair Wilson, head of retail platform strategy at Zurich, adds: “Workers may feel wealthier with more cash in their pockets, increased spending power and will come as a welcome boost for households recovering from squeezed earnings. However, this might not last long.

“As Brexit uncertainty continues to grip the nation it’s hard to be certain which way inflationary pressures will swing.”

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