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A recent poll conducted by YouGov for Citi revealed that public expectations for inflation in the UK are at the highest level in five years. Inflation expectations for next year rose to 2.9% this month, from 2.7% in August. When the time horizon was pushed out, expectations for increased prices were even higher.
Respondents to the survey felt that over the next 5 to 10 years, inflation would rise to 3.4%, from 3.3% in the previous poll. Higher expectations for prices appear to be tracking actual inflation in the UK economy, which is on the rise.
A week ago the The Office for National Statistics (ONS) announced that August’s consumer price inflation (CPI) had come in at 2.7%, which is two tenths of a percent higher than July. This was a surprise, as economists that had been polled prior to the CPI print had expected a rate of just 2.4%.
Brexit Seems to be Driving Inflation
Price levels in other developed economies is still relatively subdued. Eurobloc CPI came in at just 2.1% in July, which shines a light on the difference in increacing prices between the UK and EU. The UK’s inflation rate has been in flux since the Brexit vote in 2016. After voting to leave the EU caused a major drop in the exchange value of the pound, import-driven price increases have been causing prices paid in the UK to fall out of line with other major economies.
According to a statement issued by Mike Hardie, the ONS’ head of inflation, “Consumers paid more for theatre shows, sea fares and new season autumn clothing last month. However, mobile phone charges, and furniture and household goods had a downward effect on inflation.”
Consumers could also be reacting to rising energy prices. The CPI, which is widely watched by central bankers economists, doesn’t include energy costs. UK consumers swallowed numerous prices rises for just about every kind of energy this year, which is probably putting upward pressure on their future expectations for inflation.
The Pound Seems to Play a Leading Role
The price rises that followed the Brexit vote appears to be mostly tied to the exchange value of the pound. A rise in prices based on a weakening national currency isn’t ideal, but there are other economic benefits that can arise from a lower exchange rate. The UK is still exports numerous goods, and if the pound falls in the wake of Brexit next year, there will probably be some economic good that comes from a weakening pound.
Opinions are mixed as far as where prices in the UK could go next. Consumers clearly think that long-term inflation could be on the rise. Professional economists on the other hand, see prices moderating. Ruth Gregory, senior UK economist at Capital Economic, wrote this in the wake of the higher-than-expected print, “The unexpected rise in CPI inflation from 2.5% to 2.7% (consensus 2.4%) came as a bit of a nasty surprise, but it does not alter our view that CPI inflation will be back at the 2% target by this time next year.”
The exchange markets reacted strongly to the specter of rising inflation, pushing the pound up against the other majors. Higher prices have been on the agenda at the Bank of England, and was cited as one of the reasons why they decided to raise interest rates earlier this summer.
No Problems Yet
Despite the unexpected rise in both actual inflation, and expectations, a sub-3% level probably isn’t dangerous. It is worth remembering that for most of the 20th century, interest and inflation rates were much higher than they have been over the last decade.
The ultra-low interest rate environment that was introduced after Lehman Brothers imploded has been met with criticism, especially from a generation of savers who now have to make a near-zero rate of interest work for their retirement. If Brexit does spur a bout of rising rates in the UK, it may be a blessing for savers who could use some higher returns on a lifetime’s worth of prudence.
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