UK inflation: Higher; Mixed versus expectations

The jump in UK CPI inflation from 2.5% to 3.0% year-on-year was worse than expected and not really about rising underlying domestic inflation pressure.

It comes despite a backdrop of pretty flat activity growth in the UK economy. In and of itself, that’s clearly not great news for consumers or for prospects of hitting the 2% inflation target anytime soon. However, the numbers as a whole were mixed versus expectations and don’t mean that the Bank of England (BoE) is going to stop cutting interest rates.

A sizeable rise in UK inflation was very much expected in January, but the size of the increase was mixed versus expectations. January headline CPI at 3.0% came in higher than consensus (2.8%) after 2.5%. Core CPI, however, at 3.7% was in line with consensus, though that still marks a jump from 3.2% in December. Services inflation rose less than expected though to 5.0% from 4.4% (consensus: 5.1%). RPI was also a touch lower than consensus (3.7%) at 3.6% after 3.5% too.

Not really about underlying domestic inflation pressure: I wouldn’t describe much of the rise in inflation in January as reflecting higher underlying domestic inflation pressure. That matters for the inflation outlook and for prospects of rate cuts.

The transport component added 0.3pp (percentage points) to year-on-year inflation driven by air fares and fuel. Air fares (alongside fuel) are a volatile factor, falling less than usual month-on-month after a lower than usual rise in December. Food and non-alcoholic beverages added 0.15pp. January also saw the introduction of VAT on private school fees which helps explain the education component adding just short of another tenth.

Beyond the education, food and transport components of inflation, there were several other movers in the data this month but with a mixture of downward and upward effects on inflation. Six out of the 12 major categories of CPI inflation contributed positively to the move in inflation in January. Digging into the services category, outside of transport services (which will include air fares) and education, most of the rest looks flat or lower (in terms of year-on-year inflation), though there was a pick-up in rents and package holidays.

UK inflation is likely to rise in coming months on higher electricity and gas prices

UK inflation is expected to rise further in coming months: UK inflation is likely to rise in coming months on higher electricity and gas prices. Bank of England staff, for example, were already expecting CPI inflation to jump to 3.6% in April, owing in part to energy prices. However, they are also assuming that so-called second-round effects don’t result – i.e. they assume that the rise in inflation won’t then see a subsequent rise in domestic prices and wages.  

What do today’s figures mean for the BoE?  Staff forecasts published earlier this month indicated 2.8% for headline inflation and 5.2% for services inflation. So today’s figures are mixed versus their forecasts (importantly with services inflation lower than expected) and don’t seem obviously likely to knock them off their rate cutting path. However, with that big assumption being made by the BoE around second-round effects, they seem likely to remain gradual/cautious/careful – at least until they get more evidence to support their assumption. For now, I continue to expect the next BoE rate cut in May.

UK: Headline, Core, Core Goods & Services Inflation

Source: LSEG Datastream as at 15/01/2025

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