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The true cost of prices rising faster than wages

true cost prices rising faster than wages

FINANCIAL ADVICE WITH KEVIN CLANCY: The true cost of prices rising faster than wages

The UK’s inflation rate has fallen for the first time since June – 3 per cent in December, down from November’s six year high of 3.1 per cent – mainly because of air fares.

The Office for National Statistics (ONS) said that while air fares did rise last month, that increase had a smaller impact than at the same point in 2016. A drop in the price of toys and games also contributed to December’s fall. The ONS said it’s still too early to say whether this was the start of a longer-term reduction in the rate of inflation.

The Bank of England, on the other hand, thinks inflation peaked at the end of 2017 and this time really will fall back to its target of 2 per cent some time this year. Prices have been rising the past year in large part due to the fall in the value of the pound since the Brexit referendum which, at a stroke, meant imports were always going to get more expensive.

Yes, the Referendum and the ensuing fall in the value of sterling were more than a year-and-a-half ago but because many retailers buy their stock a year or two ahead, the increased cost of imports has only started to bite in the past few months.

If one separates the increasing price of goods from the price of services then inflation is 3.4 per cent, higher than it’s been for more than five years.

The Retail Prices Index (RPI), a separate measure of inflation, rose to 4.1 per cent last month, up from 3.9 per cent in November.

The ONS’s preferred measure of inflation, CPIH, which includes owner-occupiers’ housing costs, fell to 2.7 per cent in December, down from 2.8 per cent the month before. In plain English, what this means to all of us is that because wage growth has been below the level of inflation, we as individuals, are not feeling any benefit from an improving economy.

Food prices will continue to increase as a result of the decrease in the value of the pound against the euro.

Interest rates

Oil prices have already increased and the cost of mortgages will increase as interest rates need to rise to combat inflationary pressures. In November, the Bank’ Monetary Policy Committee (MPC) raised its key interest rate for the first time in more than a decade from 0.25 per cent to 0.5 per cent.

Companies will find that labour shortages and the demand for increased salaries will increase the cost of their overheads. Samuel Tombs, chief UK economist at Pantheon Macroeconomics, thinks the next rate hike doesn’t have to be just around the corner.

“The continued weakness of underlying price pressures means that the MPC has little need to rush the next rate hike,” he said.

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Aberdeen Standard Investments’ chief economist Lucy O’Carroll agreed: “What matters most for the long-term health of the UK economy is improving its productivity performance. If we can do that then the Bank of England may be able to keep rates low for a lot longer. But on recent experience, improving productivity is much easier said than done.”

Because the Bank of England is obliged to get inflation down to the 2 per cent mark trading in the City currently forecasts the next interest rate rise will take be in August.

Laith Khalaf, senior analyst at Hargreaves Lansdown, said that the drop in inflation was not enough to “significantly ease the pressure on UK household spending” because wages were still rising by less than the rate of inflation. It that changes then “a sustained trend of falling inflation and better wage growth could spell happier times for the UK consumer, and the UK economy”.

Howard Archer, chief economic adviser to the EY Item Club, said: “We suspect that relatively lacklustre economic growth will continue to limit domestic price pressures. Earnings growth seems likely to pick up only gradually as some firms remain keen to limit their total costs in a challenging and uncertain environment.

“Fragile consumer confidence may also deter so some workers from pushing hard for increased pay rises, despite recent higher inflation and a tight labour market.”

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