The Recent Past and Likely Future on UK Inflation

UK inflation eased more than analysts’ consensus forecast in November, from 4.6% y/y to 3.9% using the widely reported Consumer Price Index (or from 4.7% to 4.2% using the Office for National Statistics’ preferred measure, which excludes owner-occupiers’ housing costs).^[i] Let us get the political takes we saw out of the way: The Conservative government talked things up, highlighting their fulfilled pledge to halve the inflation rate by yearend (though we don’t think any government of any partisan persuasion has that much control).^[ii] Yet Labour made the observation that price levels were still up.^[iii] We see plenty of truth in both observations, but in our view, this is all largely irrelevant for stocks, which we find move on the gap between reality and expectations and leave political personalities out of it. However, we think one of the main factors slowing the UK’s inflation improvement—which happens to be the same factor we think points to further significant improvement next year—is 100% political and bipartisan. We think stocks are well aware of this already, but a quick look can help investors put all the data in proper context.

We speak, of course, of the household energy price cap, which Labour proposed and the Conservatives ran with. Intended to prevent runaway electricity price increases, it became an effective price target for power suppliers, and it rose in giant stairstep increases (first every six months, then every three) as gas and wholesale power prices rose.^[iv] Once those started falling last year, the cap prevented suppliers from immediately passing those cost savings to consumers.^[v] Meanwhile, as the cap skyrocketed in 2021, the government chose to deal with it by establishing a secondary ceiling, where it would subsidise energy costs above £2,500 per annum.^[vi] Therefore, households didn’t actually experience reduced energy costs until the regulatory price cap fell below that mark.

This magic moment finally arrived in July, by which time UK wholesale power prices were about -80% below their October 2022 high.^[vii] And in October, the relief finally showed up in the UK inflation rate: The “electricity, gas and other fuels” component flipped from a 5.0% y/y rise in September to -21.6%, a rate it matched in November.^[viii] This wasn’t the only source of inflation improvement, as food and core (excluding food and energy prices) inflation slowed last month, too.^[ix] But it was a big contributor.

And, in our view, will likely remain so despite the energy price cap increase announced in November, which will lift the cap by 5% to a £1,928 average annual rate in January.^[x] Not pleasant, but still far below costs a year prior.^[xi] In our view, even that uptick looks temporary. In April, industry analysts estimate it will fall -14% to £1,660.^[xii] That would be over -30% below the price ceiling that reigned in April 2023, so we can likely anticipate household energy’s detracting from inflation gauges for quite some time.

Which means further inflation improvement appears likely to be in the offing, which will probably inspire political rhetoric and help improve household purchasing power as wages continue catching up with consumer prices.^[xiii] We think this simple knowledge can help investors navigate sentiment as people continue (metaphorically) fighting the last war, looking for a repeat of 2022’s inflation problems around every corner. Simple math, along with easing price pressures in general, appear likely to help prevent the inflation rate from jumping anew in the foreseeable future. As always, we wouldn’t go so far as to extrapolate any of this to Bank of England interest rate decisions, which remain unpredictable, in our view. Monetary policymakers always are, in our experience, since they react to incoming data and changing forecasts (which are also based on incoming data) through the lens of their own viewpoints and biases. Human decisions aren’t a market function, in our view.

But if and when inflation fears resurge over the next year-plus, we think easing household energy prices and falling M4 money supply can help you keep perspective.^[xiv]