A Cooling Wind in October’s UK Inflation Data

Good news: The G-7’s highest inflation rate inched down in October as the UK’s Consumer Price Index (CPI) slowed from 3.8% y/y to 3.6%.^[i] Most coverage, predictably, focused on the central banking and political angles—a December rate cut is supposedly more likely now, while Chancellor of the Exchequer Rachel Reeves talked of using next week’s Budget to slow inflation further. Both takes seem beside the point to us. For investors, what matters is that the global war on inflation is over, which Britain’s stubborn rate oddly shows.

Inflation refers to broad price rises across the vast spectrum of goods and services. It erupts when money supply grows faster than society can absorb it—when too much money chases too few goods and services. This is why Nobel prizewinning economist Milton Friedman called it a monetary phenomenon. The UK’s headline money supply measure is M4 excluding intermediate other financial corporations (OFCs), which means broad money supply excluding deposits from shadow bank-type institutions whose core business is facilitating transactions among other financial institutions. While those deposits are money, they are unlikely to actually be used as a medium of exchange, so the Bank of England excludes them to get an accurate read.

The UK’s hot 2022 inflation followed M4 ex. intermediate OFCs’ spike to 15.2% y/y in February 2021.^[ii] Money supply is much tamer now, at 4.4% y/y in September, within its narrow 2025 range.^[iii] Similar growth rates coincided with benign inflation throughout the mid-to-late 2010s. So in the UK—like the US, eurozone and other places with tame inflation—money supply doesn’t look inflationary.

Yet the UK has higher inflation, so what gives? Sometimes, external factors affect prices in select categories for a spell. For a while now, three main forces have spurred UK inflation: home energy, water and food. Household energy (electricity and gas) was a big driver of CPI’s October slowdown, thanks to the resetting price cap. Despite its name, the price cap has not capped prices. Instead, it sets a ceiling for utilities’ standard rates, which regulators review and reset as wholesale power and gas prices change. Price ceilings always end up being targets, which resulted in huge stairstep increases as prices rose. When wholesale prices fell, utilities wouldn’t pass it on to customers until the cap reset lower, leading regulators to shift from a semiannual reset to quarterly. October’s reset reduced the inflation rate in Electricity, Gas & Other Fuels from 9.4% y/y to 2.2%—a substantial decline.^[iv] 

Utility quirks also explain water supply and sewage collection’s seven straight months with a 26.1% y/y inflation rate.^[v] We won’t bore you with a long rehash here, but the UK’s water sector is in crisis, beset by aging infrastructure, a lack of investment, sewage spills and severe financial problems at a major provider. There are a lot of political and financial machinations at work, including a regulatory reset and talk of nationalization, but the upshot for now is painfully higher bills as customers shoulder the cost.

As for food, it is worth noting UK food prices have cooled tremendously since 2022, but the food inflation rate has crept back up from 1.9% y/y last November to 4.8% in October.^[vi] The main sticky points today are meat, chocolate and grains. Meat and chocolate prices are up globally, due largely to supply disruptions. Grain is more of a domestic issue, with unfavorable weather leading to a poor harvest and higher-than-usual imports.

Food, energy and water loom large in the public consciousness. They are essential goods and services, non-negotiable parts of the household budget. This is why the UK’s higher inflation rate feels so painful to British society. But this doesn’t mean prices broadly are starting to run away again. They aren’t. Clothing and footwear prices have barely budged for months. Ditto furniture and household equipment prices. Healthcare and communication prices have slowed. Personal care and financial services prices are tame. Insurance costs have been dropping, probably to Americans’ envy. Hot inflation pressure isn’t pervasive.

So for UK stocks, we think resurgent inflation is a false fear, one of the many bricks in Britain’s wall of worry. Hard as higher essential prices are on households, their surprise power over stocks seems spent.