• UK Inflation fell to 3.9% in November 2023, its lowest level since September 2021, beating market expectations
• Food inflation fell to single-digit, core and service inflation also fell
• Rising expectations of rate-cut by the Bank of England, with markets anticipating rates will be cut by 1.38 % points in 2024
• The cost of living is expected to normalise in 2024, though no major changes till elections
• Potential headwinds include the Gaza Conflict, sticky labour market, supply chain disruption in Gulf waters

Few things in the otherwise boring world of finance excite the general public, policymakers, economists, and other agents alike. Inflation sits at the top of such a list. It affects your cost of living, mortgage costs, banks’ profitability, politicians’ chances of winning and much more. Despite its primacy in decision-making, inflation has been on a volatile ride in the post-COVID world. Predicting it and understanding its dynamics has become a fool’s game, even for seasoned economists. Hence, like a good life lesson, it can be understood by linking the past with the present to make sense of what might happen in the future.

Source: Office for National Statistics
Reasons Behind Inflation Rise Since 2020
The inflation rate had been benign in the UK in the past decade, remaining comfortably under-2% target by the Central Bank, barring an uptick from Feb 2017 to December 2018 when inflation touched 3.1% in November 2017. However, the increase was characterised by slow movement, prompting passivity by the Bank of England, which kept the interest rate unchanged for most of 2017, before increasing it by a modest 0.5% for the period. However, since 2020, various supply shocks and to some extent demand shocks led to a strong increase in inflation.
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The first major shock to inflation calculation came from the Black Swan Event – the COVID-19 Pandemic. Supply chains were disrupted due to quarantine imposed by the governments worldwide. Initially tempered demand prevented price rise, but as quarantine was lifted, increased demand along with a shortage of products and services pushed up prices. The inflation rate rose from 0.4% in February 2021 to 5.5% by January 2022. This rise was further due to large fiscal payout given by governments worldwide, along with quantitate easing initiated by central banks. According to the IMF, the cost of government Covid-19 measures was £410 billion, equivalent to £6,100 per person in the UK. Moreover, the Bank of England reduced the Bank Rate by 65 basis points to 0.1 per cent and expanded the holding of UK government bonds and non-financial corporate bonds by £450 billion. This resulted in inflation-shock from both supply- and demand-side.

Source: Trading View
The Russian invasion of Ukraine in February 2022 presented the next big impetus to inflation. It had a big impact on energy and food prices around the world. Brent Crude rose from $75 in December 2021 to $118 in March 2022. The former level was regained only in March 2023 and has remained above $80 since then. By July 2022, Transport accounted for 25% of the inflation as transport inflation was 15% as the cost of motor fuels increased by 43% during the month. Like transport, food and beverages have been in an uptrend since 2021. However, unlike transport, food inflation was more persistent. It touched its peak rate of 19.2% in March 2023 only. The overall consumer price index rose 6.2% in February 2022 and touched its peak of 11.1% in October 2022.

Some economists, including Mark Carney, the former governor of the Bank of England, posit that Brexit might partly be blamed for higher costs, especially if domestic inflation is compared with the rest of the world. The cost of hiring people went up as there was a shortage in the number of people available for work in the UK. Moreover, researchers at the London School of Economics gave evidence that between December 2019 and March 2023, extra red tape at customs could have added £250 to household’s grocery shopping bills.

Inflation’s Downward Trajectory in Recent Months
In January 2023, British PM Rishi Sunak made halving inflation one of the five pledges of his government. Delivering on it, UK inflation has fallen sharply since the start of 2023, with the consumer inflation rate declining to 3.9% in November 2023 against an expectation of 4.3%, the lowest rate since September 2021. That is a sharp fall from its peak achieved in October 2022. This contrasts with the outlook given by the central bank, which had predicted a long-drawn war against inflation, which entails trade-off with economic growth. The slowdown in price rise has been broad-based, but the major respite came from energy and food prices. On a monthly basis, CPI declined by 0.2%, compared with a rise of 0.4% in November 2022.

The November readings showed food inflation falling to single digits for the first time since June 2022. Lower wholesale gas prices in recent months due to energy regulator Ofgem’s price cap also contributed to a sharp fall in inflation. However, food prices are still high following relatively sharp rises over the last two years. Compared to an increase of 9% over the ten years between November 2011 and November 2021, the overall price of food and non-alcoholic beverages rose by around 27% over the two years between November 2021 and November 2023. The CPI services annual rate, which is closely watched by the central bank as a gauge of domestic pricing pressures, eased from 6.6% to 6.3%, while the CPI goods annual rate slowed from 2.9% to 2.0%. Excluding the volatile energy and food prices, core inflation also decelerated to 5.1% in November, down from 5.7% in the previous month.

Source: Office for National Statistics
Even though the headline CPI growth remains higher in the UK than equivalents in the US and the EU, the public’s expectations for inflation dropped to 3.3 per cent in November, from 3.6 per cent in August, falling to the lowest level in two years last month. The deceleration in the inflation rate is similar to other developed economies, suggesting a global easing of prices and the end of the monetary tightening cycle. Moreover, faster-than-expected fall in inflation has prompted increased expectations of an interest-rate cut early next year as rates sit at a 15-year high at the moment. Markets anticipate rates will be cut by 1.38 % points over the course of next year, with the first cut of 0.25 % points by May – far earlier than Bank of England’s or market’s earlier expectations.
Interest Rate Move by BoE

Source: Bank of England
As can be seen in the chart, before the Global Financial Crisis of 2008, the interest rate was 5.75%. However, within the span of 18 months, the rate had been cut to 0.5%, reaching an all-time low to support economic growth. After keeping the interest rate at the same level for more than 7 years, the rate was further cut to 0.25%. The BoE started incrementally increasing it in November 2017. However, it was further cut to 0.1% in May 2020 in the post-COVID world to complement the expansionary fiscal policy of the government to reach an all-time low of 0.1%. The increasing inflation rate forced the central bank into successive interest rate hikes since December 2021 to reach 5.25% by August 2023. This level was last seen in March 2008.

Post the global Financial Crisis of 2008, signalling by the Central Banks has become an important tool in their arsenal. And so far, the BoE has been hawkish, offering no signal of a rate cut in the latest meeting in November. This was in divergence with the US Fed, which expects a 0.75 % point cut in 2024. This announcement took the financial markets by storm, shooting global indices to all-time highs, but the BoE remained unperturbed. In fact, it signalled the possibility of an increase in interest rate if inflation doesn’t subside, though participants doubt the credibility of the announcement, not least due to contradictory statements by the Fed.

According to the officials at the Bank of England, before it can conclude that the war against inflation has been won, the bank will wait for conclusive evidence in the labour market and it will not rush into lowering interest rates. Moreover, they will look for more than just easing inflation before monetary easing is undertaken. Ben Broadbent, a deputy governor of BoE, remarked that it has been hard to gauge how fast wages were growing and the reasons behind its growth because of volatile, inconsistent data as presently Office for National Statistics is not publishing its estimates of unemployment due to faults in survey methodology. The dynamics behind wage increases have been unclear as well leading to uncertainty whether wages have been rising because workers are in short supply or mostly as a one-off response to the sharp rise in consumer prices. This is an important question as it will determine if wage growth will continue to fuel prices of labour-intensive services, which have remained too high for comfort and above the levels which will assist inflation to fall back to the target of 2%.

Potential Headwinds in Fight Against Inflation
All this suggests the central bank would prefer to potentially be behind the curve for an “extended period of time” in order to be certain of the downward path and it would be reluctant to make a quick change of course. This was reiterated by Huw Pill, the bank’s chief economist, as well when he said that to control growth in both wages and services price inflation, persistently tight monetary policy will be needed. Higher wage growth has supported higher service inflation in the UK than elsewhere, suggesting the British labour market is still tighter than before the pandemic. The bank also remains anxious to avoid criticism that it might underestimate the inflation outlook and of “complacency after having battled to regain its inflation-fighting credibility by lifting rates 14 times in a row to reach a 15-year high. The geopolitical risks haven’t subsided, leading to the continuing threat of supply chain disruption, not least to shipping in the Red Sea because of attacks by Houthi rebels which can drive up the price and/or cause longer waiting times.

The latest Minutes of the Meeting of November showed bankers genuinely fear the UK is in a deeper hole with regard to inflation than its peers as almost all inflation metrics remain higher than the average of developed countries. There are many reasons why the UK is worse off with regard to inflation than other countries. This includes the fact that the UK imports around 50% of its food, making it the world’s third-largest net importer of food and drink. Thus, it is more reliant on imports than other developed countries. In the last couple of years, import prices have gone up a lot more than domestic food, mainly due to additional transportation costs and costs associated with Brexit red tape. Moreover, compared to other European countries, the UK is more exposed to gas price spikes and is more reliant on it to heat homes and keep lights. While France generates more power from nuclear plants and the US produces most of its own gas, the UK’s gas imports were mainly via pipelines from a handful of suppliers. Additionally, regulation of energy prices resulted in slower and lower pass-down of gas prices when international prices fell. Wage increase, too, has been higher in the UK as it has experienced the worst post-pandemic worker shortages. Compared to December 2019, the UK still has a lower workforce as almost 400,000 people haven’t rejoined the labour market at a time when most leading economies have recovered almost all of their workforce. The situation has been further exacerbated by labour shortages due to Brexit.

Can Public Expect Respite from Inflation
The recent data show a glimmer of light as a downward trajectory of inflations means the bank will not have to resort to deep recession to bring inflation back to its 2 per cent target. Moreover, slowing inflation suggests the cost-of-living crisis will ease, bringing much-needed respite to the public. The mortgage cost will decline as the interest rates are cut while the real wages have been increasing with easing inflation along with a tight labour market. Also, the hawkish stance of the Bank will come under pressure due to various reasons, including a rate cut by the Fed, possible British elections in 2024, the need to support the flagging economy, and deceleration in inflation metrics.
Thus, we believe that the Bank of England will be slow in its rate-cut decision, although both political and economic pressure will start to increase by mid-2024. The bank has been sounding more hawkish to tame the market. Interest rates will continue falling but the deceleration will normalize, suggesting inflation won’t touch the target of 2% but will remain comfortably around 2.5%. This is barring supply shocks from risks emanating from the Red Sea or the threat of the Gaza crisis becoming a regional conflict.[/subscribe_to_unlock_form]