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UK inflation not falling fast enough

Secondread and According to the Roman satirist Juvenal, the circus offered a path to social peace. The latest UK inflation data, released on April 19 and covering the year to the end of March, may worry him. Soaring food and entertainment costs have kept annual price growth in the double digits.

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Food comes first. Rising energy prices following Russia’s invasion of Ukraine raised the cost of fertilizers; last year’s heatwave shortened the growing season in Britain’s trading partners. The price of olive oil, mainly imported from Spain, jumped 49 percent as unseasonably warm weather affected production. Many staple foods that account for a large share of spending by poorer households have been hit hard. Inflation for bread and cereals was 19.4%, the highest since the Office for National Statistics began tracking in 1989.

The well-known source of “entertainment and culture” price spikes is harder to pin down: the makeup of video game bestseller lists can have a huge impact on monthly rates. But the gains there, along with higher food prices, were more than enough to offset most of the decline in gasoline prices. That kept inflation almost at 10.1%, just below the 10.4% reported in February.

Post-pandemic inflation in the UK is stubbornly higher than many of its peers (see chart). Economists had expected a drop to 9.8% in March. Euro zone data released on the same day showed the bloc’s inflation rate fell to 6.9 percent, despite many of the same pressures on food and energy prices following Russia’s invasion of Ukraine.

This difference is partly a matter of timing. Britons have yet to enjoy the effects of lower wholesale gas prices. The interaction between energy price caps (EPC), limits on how much suppliers can charge customers, and an energy price guarantee that fixes the unit rate households pay, means consumers and wholesale gas prices are not as tightly linked as in other European countries. In Spain, where consumer prices are closer to wholesale prices, year-over-year inflation was just 3.1% in March.

However, UK headline inflation is set to drop sharply next month due to “base effects” rather than any positive economic news. The first price cap increase after Russia invaded Ukraine will be in April 2022, meaning year-on-year figures will drop next month. As a result, consumer natural gas prices in April 2023 will be 27% higher than a year earlier, instead of 96% in March. According to economists at Investec Bank, this will reduce headline inflation by about 1.7 percentage points next month.

Good news may soon come in the form of lower food prices, too.International Commodity Price Index United NationsThe Food and Agriculture Organization found that food costs were 20 percent lower in March than a year earlier, when prices soared after the Russian invasion.

Once food and energy are excluded, the UK’s inflation experience appears to be more in line with that typical of Europe. In the UK, so-called core inflation, which excludes these two categories, was steady at 6.2% in March; in the euro zone, it edged up to 5.7% from 5.6% in February. Headline inflation in Spain is likely to be much lower, but “core” inflation is 7.5%, higher than in the UK.

Still, investors increased bets that the Bank of England would raise interest rates to 4.5% from 4.25% at its next meeting on May 11. Market pricing now implies that the main policy rate will peak near 5% in November, rather than 4.75%. It could also be because labor market data released on April 18 showed that wage growth was slowing, but still high (6.6% in the three months to February). Bread and circuses may be in short supply, but jobs won’t. This combination is bad for inflation.

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