CPI inflation: Double-digit inflation points to a super-sized hike

The rise in inflation to 10.1% in September makes it even more likely that the Bank of England will opt for a super-size rate hike of a full percent at its meeting on 3 November. Inflation is still on track to peak at almost 11% in October before it will start to decline rapidly. But the potential removal of the energy price guarantee has put a big question mark over the outlook for inflation next year.

Core inflation continuing to rise

At 10.1%, inflation has returned to its 40-year high. The rise in October was largely driven by food and drink inflation, which jumped from 13.1% in August to 14.5% in September. There were also significant rises in clothing inflation (7.6% to 8.5%) and restaurants and hotels (8.7% to 9.7%). These were, however, partially offset by a drop in fuel price inflation from 32.1% to 26.5%.

As a result, services inflation rose to 6.1% and core inflation, which excludes volatile foods and energy prices, rose from 6.3% to a new 30-year high of 6.5%. That will be cause for concern among policy makers – services constitute around 45% of the CPI basket, and price rises tend to be stickier. Inflation in this category is significantly above the 3.3% average seen between 2000 and 2019.

Admittedly, the end of a temporary sales tax cut on the hospitality sector accounts for some of the increase in services inflation in recent months. But price pressures are also closely linked to the labour market, where private sector wage growth is running at 6.2% y/y.

The good news, though, is that pipeline pressures eased for the third straight month in September. Inputs price inflation, measured by the Producer Price Index, fell to 20% from the prior reading of 20.5%.

What next?

In the very near term, inflation is likely to jump to a little under 11% in October as the 27% rise in energy prices kicks in. It should then fall back sharply until at least April as the previous large rises in food and fuel prices drop out of the annual comparison.

After that the outlook becomes much murkier. The government U-turn on almost all of the measures in the mini-Budget and the upcoming period of austerity will reduce demand, and should feed through into lower core-inflation over the next year. However, there are two possible wildcards that could result in higher inflation.

First, inflation could be significantly higher next year, depending on how the energy price cap is reformed from April. Removing the cap completely could push inflation in April back to around 11% based on current market pricing, compared to if the cap remained.

Second, the main reason that the labour market is tight is because of a huge rise in the number of people on long-term sick leave. If these people do not return to the labour market, wage inflation may not fall as quickly as anticipated. This would make inflation stickier.

The policy takeaway

Today’s release makes it even more likely that the Bank of England will opt for a super-sized rate hike of a full percentage point on 3 November. Indeed, the BoE delivered an outsized 50bps hike at its September meeting, while also forecasting a recession as deep as the one seen in the 1990s. The message was clear – a downturn is the cost it is willing to pay to get inflation back under control.