UK inflation spikes to new four-year high, tightening consumer squeeze

UK inflation surged faster than expected to a new four-year high in May, according to official figures published on Tuesday that highlight the increasing squeeze on households as price rise faster than wages.

The consumer price index was up 2.9% year-on-year in May, the highest level since June 2013 and up from 2.7% in April.

Inflation in May was higher than the market was expecting, with a consensus forecast from economists of 2.7% and 2.6% from the Bank of England.

On a monthly basis, the Office for National Statistic revealed CPI rose 0.3% in May compared to April, down from the 0.5% rise that month but greater than the 0.2% rise economists had forecast.

Although fuel prices eased, this was offset by rises in prices for computer games and package holidays in particular.

While the Bank of England remains concerned by inflation, now well above the annual rate wage growth of 2.4%, as the rate-setting Monetary Policy Committee meets this week, the central bank is intent on 'looking through' this spike in inflation, with the increased political uncertainty giving even less of a chance of an interest rate rise soon.

CPIH, the ONS's preferred new measure of inflation as it includes owner-occupiers' housing costs, rose by a slightly higher than expected 0.3% month-on-month but remained at 2.6% compared to the same month last year, as expected.

Core CPI, which excludes more volatile prices such as food and fuel, rose to 2.6% YoY from 2.4% the prior month, where it was forecast to remain.

After the unexpected rise in CPI, Paul Hollingsworth at Capital Economics said he though inflation is now not far away from its peak and, coupled with political uncertainty, means May's figures "shouldn’t worry the MPC".

He also noted that price pressures at the start of the supply chain are beginning to slow, with producer input price inflation fell back sharply from 15.6% in April to 11.6% in May, while output prices held steady at a much lower 3.6%.

"This supports our view that the drop in the pound has fed through faster than expected, rather than by a larger amount. As a result, while we think that CPI inflation will peak at a little above 3% before the end of this year, it is likely to drop back fairly quickly in 2018."

SQUEEZE ON HOUSEHOLDS AND BUSINESSES

The rise in prices is exerting a powerful squeeze on UK consumers as wage data has flatlined, meaning pay is shrinking in real terms, with the effect, as proven by a report from Visa on Monday, that consumer spending dropped for the first time in nearly four years.

Further data from the ONS on Wednesday is expected to confirm the ongoing weak wage growth.

"The general mood on the economy has become one of caution over the past few weeks, with first-quarter GDP figures disappointing, consumer spending looking weaker and Brexit-related uncertainty looming large," said economist Ben Brettell at Hargreaves Lansdown.

"However, growth is expected to pick up somewhat in the second quarter, and it looks like the election result could make for a ‘softer’ Brexit, which could prove positive for the economy."

The tightening of consumers' belts is bad news for an economy which relies on confident consumers spending on goods and services, said Maike Currie, investment director at Fidelity.

“Already we are seeing signs of a stagnating economy as confidence among companies and consumers falter. Election result paralysis will only add to the UK economy’s woes," she said.

“Inflation never seems like a problem until suddenly it is and while it may be good news for borrowers, as it erodes the value of their debts, it has detrimental implications for savers, investors and retirees, chipping away at the value of future interest and dividend payments and eroding the worth of your capital pot.

"Once pricing pressures become entrenched, consumers’ feel the pain, businesses don’t invest and the stock market gets worried."

Higher inflation is also a key business concern, the British Chamber of Commerce pointed out, as it squeezes margins and weakens companies' ability to invest, particularly during this time of heightened political uncertainty.

A recent economic survey by the BCC confirmed that businesses were continuing to feel the inflationary pressures, with a significant proportion of firms struggling to absorb the rising cost of raw materials and other overheads - a task made more challenging by the myriad of upfront costs imposed on businesses.

The BCC's demand that the MPC provides monetary stability and keep interest rates on hold during the political instability by continuing to ‘look through’ the expected increases in inflation, indicates one of the key factors that lies behind the central bank's decision making, as well as the impact on highly leveraged households.