Has UK inflation turned a corner?

Please note: The article does not constitute advice or any form of investment recommendation. All numbers quoted were sourced from Bloomberg data as at Wednesday 18 January 2023. Past performance is never a guarantee of future performance.

In a further sign that the global battle against price pressures might have turned a corner, the UK has reported a fall in inflation to 10.4% in December, down from 10.5% the month before. 

The news echoes events across the pond – read our separate article US inflation cools – and represents the second consecutive monthly fall, having posted a decades-high of 11.1% in October.  

The latest data heaps further pressure on the Bank of England (BoE) to tread carefully with rate hikes this year, as it balances inflation control with the effect on growth. 

What’s behind the fall?

The fall in the consumer prices index (CPI) was mainly driven by lower fuel prices, at a time when UK households – and specifically, disposable household income - continue to benefit from the government’s energy cap.

Meanwhile, the more volatile retail price index slowed to 13.6% in December (down from 13.4% in November).

Cautious optimism

From a headline perspective, the moderation in CPI seems good news, but core inflation remained stubborn at 6.3%. This adds to the pressure on the BoE to hike further, and potentially higher, than so far anticipated. 

Recent gross domestic product figures have potentially provided the central bank with more freedom to hike, given the domestic economic resilience seen so far, and despite the ailing housing market. 

Meanwhile, core inflation is likely to be driven by the tightness in the labour market. This week’s Office for National Statistics (ONS) report showed stubbornly-high wage growth at 6.4%¹, with private sector wage growth comparatively high at 7.2%. On the flip side, the public sector is potentially adding to the pressure given ongoing industrial strikes in the search for higher wages. 

Where next?

Against this backdrop, the BoE may feel the need for more rate hike urgency, and to head towards a terminal rate of 4.5%, which is also in line with current market pricing. 

As Governor Andrew Bailey commented this week: “Going forwards, the major risk to inflation coming down in the way that it will is the supply side. In this country particularly, the question of the shrinkage of the labour force"².

The vulnerability of the UK economy makes potential rate cuts seem more realistic towards the end of this year. For now, it’s a question of focusing on long-term investment objectives and cutting out short-term noise.

Please note: Our monthly Market Perspectives report returns on 6 February 2023.

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