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UK Inflation: "The Largest Ever Recorded Increase in CPI", and there's More to Come say Economists

Sunak Eat Out to Help Out

Above: Treasury image showing Chancellor Rishi Sunak promoting the Eat Out to Help Out scheme. It contributed significantly to August 2021's hike in inflation.

The ONS says the rise in UK CPI inflation in the 12 months to August 21 constitutes the "largest ever recorded increase" since the current series began in 1997 and economists warn even bigger inflation surprises await.

CPI rose 3.2% in the year to August said the ONS, up from 2.0% in the year to July, which is above market expectations for a rise of 2.9%.

CPI increased 0.7% from July to August, which is greater than the previous month's change of 0.5% and above the consensus expectation for 0.5%.

inflation UK August 2021

Core CPI rose 3.1% year-on-year to August, up on the 1.9% recorded in July and greater than the 2.9% expected by the market.

Core CPI rose 0.7% in the month to August, ahead of the 0.4% expected and the 0.5% recorded in the previous month.

The ONS is keen to stress that much of the hike in prices relates to base effects caused by the lockdowns of 2020. In particular, in August 2020 many prices in restaurants and cafes were discounted because of the government's Eat Out to Help Out scheme.

As a result of Eat Out to Help Out "the upward shift in the August 2021 12-month inflation rate is likely to be temporary," says the ONS.

Eat out to Help Out

Above: Inflation would have been lower were it not for Eat Out to Help Out a year previously.

Nevertheless, contributions from price rises also came from transport, recreation and culture, food and non-alcoholic beverages and hotels.

As the above chart shows, even with Eat Out to Help Out removed, inflation would be significantly higher in August 2021.

A shortage of drivers and pressures on logistics chains is reflected by transport's upward contribution of 0.87 percentage points in August 2021.

The ONS says this is the largest upward contribution from any division this month and the largest from transport since November 2011.

But much of the increased cost of transportation is also due to the rising cost of fuel the ONS finds.

Average petrol prices stood at 134.6 pence per litre in August 2021, compared with 113.1 pence per litre a year earlier.

The August 2021 price is the highest recorded since September 2013.

Demand for second-hand cars is also adding pressure to UK prices, mirroring a similar situation in the USA.

A global chip shortage means new car production has slowed sharply in 2021 while increased consumer demand for vehicles owing to the Covid crisis is also contributing.

Used cars driving inflation

Economist Samuel Tombs at Pantheon Macroeconomics says used car prices are to blame for the upside surprise (given the Eat Out to Help Out Effect was anticipated) and he saw little near-term momentum in the rest of the core basket.

The return of air travel over the summer is meanwhile starting to show up in price dynamics once more says the ONS, albeit in a small way.

When travel reopens fully and passenger demand returns expect this component of CPI to rise sharply as a battered industry struggles to deliver capacity.

Looking ahead, further price rises are likely says Paul Dales, Chief UK Economist at Capital Economics.

"A further rise in inflation to at least 4.2% already seems in the bag," says Dales.

This would surpass the Bank of England's current upper forecast for inflation in 2021 to peak at 4.0%.

"The scheduled rise in utility prices will add 0.7ppts from October and base effects will mean clothing inflation adds 0.3ppts in November," says Dales.

"We’re also expecting a further pass-through of costs to mean food inflation adds at least another 0.3ppts. As such, inflation may be 4.5% by November," he adds.

But, inflation is expected by Capital Economics to fall sharply in 2022 as a lot of these upward influences unwind.

"By the end of 2022, it may be below 2.0% again," says Dales.

Perhaps the most lively discussion in global economics at the present time is over whether current hot inflation rates will prove temporary or persistent.

The answer is critical to monetary policy as central banks would have to push interest rates higher in the face of persistent inflation.

With Capital Economics sitting in the 'transitory' camp it is therefore understandable that they don't anticipate the Bank of England to raise rates in 2022.

This would disappoint current market consensus and would trigger a readjustment lower in the value of the Pound as a result.

Pantheon Macroeconomics forecast a rise in inflation to 4.0% before the year is out with the next major jump due in October, when Ofgem will increase the default tariff price cap for electricity and natural gas by 12.2%.

Hospitality and tourism businesses are meanwhile expected to pass on some of the costs associated with the rise in the rate of VAT for those sectors to 12.5%, from 5%.

"A further easing of the drag from food prices, alongside further big rises in core goods prices linked to the recent surge in producer output price inflation, also will push up the headline rate," says Tombs.

He also warns that Chancellor Sunak's October 27 budget will likely see more taxes levied on alcohol and tobacco.

However, Pantheon Macroeconomics anticipate inflation will drop quite quickly again in 2022.