The return of inflation | EEF

The return of inflation

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The consumer price index accelerated to 1.2% in November 2016, its highest rate since October 2014. This is a clear signal that inflationary pressures are building up in the UK economy after more than two years of subdued growth in prices. With global commodity prices on the up and the Sterling depreciation expected to fully pass through to CPI next year, this inflationary trend is expected to gather further momentum as we head into 2017.


Fuelling inflation

The largest upward contributor to the inflation rate between November 2015 and November 2016 was the increase in the price of fuel used by the transport sector. Long-time coming, this increase reflects base effects from the large fall in the oil price in 2015 dropping off the inflation calculation.  But there’s more coming, with OPEC’s decision to cut output likely to further bolster oil prices going forward.



On the other hand, deflation in food and drink prices continued, providing the largest downward contribution to the inflation rate in the year to November 2016, as the supermarket price wars continue to take their toll on CPI inflation.


More input price pain for UK manufacturers

The increase in prices of imported materials in November 2016 signals that pressures from the Sterling depreciation continue to make their mark. But in the post-referendum balance sheet for the UK economy, there is one item most analysts agree is firmly on the asset side; the sterling-induced export boost.

While to an extent true, here at EEF we’ve gone at pains to point out that the impact of the sterling depreciation on UK manufacturing is considerably more nuanced that most people expect. And one channel for this – the increase in input prices through higher import costs – can already be seen starkly in official statistics.




Input prices continued their ascent, increasing by 12.9% in the year to November, compared to a meagre 2.3% increase in output prices, with the price of imported metals increasing by a staggering 35% and crude oil by another 22%. This is inevitably squeezing manufacturers’ profit margins, who have been unable to pass on the increase on production costs to customers…yet.




Hit on consumer pockets forthcoming

The negative impact of input price inflation on manufacturing – as well as other industries – is only the first prognosis of a wider trend expected to hit the UK economy in 2017.  As production costs balloon for corporates they’ll look to pass on those costs to customers aka UK consumers. The effect of that will start feeding into CPI inflation over the course of 2017.




The above graph illustrates that according to our inflation forecast and assuming that growth in average earnings continues at the pace set in 2016 – and there is no real reason for thinking otherwise as most pay rounds occur in January, well before inflation is expected to peak – consumers will start experiencing negative real wage growth from April 2017. With consumer spending the main engine of growth for the UK economy in the past few years, this trend can explain the slowdown in GDP expected by most forecasters in 2017.


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