EEF blog

Insights into UK manufacturing

Why isn't inflation lower?

Jeegar Kakkad September 15, 2009 09:46

Back in March we expected RPI inflation to be -3.3% in August and CPI inflation to be 0.4%.

What's keeping prices higher than expected?

Well the economy has turned out worse than expected, suggesting the output gap (the difference current output and what it could be if the economy was fighting fit) was greater than we thought. All else equal, economic theory suggests that prices should moderate (either disinflation or deflation depending on the circumstances).  

But as is usually the case in the economy, all else is not equal. Since March the BoE has spent over £125bn in unconventional ways. Output has stabilised enough to suggest a small summer bounce. And until recently, household budgets had benefited from weaker prices and the VAT cut.

More recently, oil prices rose 12% between July and August, and a quarter between May and August. That's helped push petrol prices - and consequently the inflation rates - higher than expected.

And despite the traditional theory and evidence suggesting monetary policy only has an impact 18-24 months out, I still think planning to pump £175bn in to the economy on top of the sharp interest rate cuts at the end of last year has to have had some effect on prices over the summer.

But more importantly, we're seeing weaker retail sales as pump prices rocket up and, more generally, prices prove stickier than expected.

 

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