A view from London

What went wrong?

Regulated prices, those set by industry regulators or government, and wage costs, are the two main culprits.

In January the water regulator signed off on a 26% increase in water and sewerage bills to fund a major programme of capital spending to reduce pollution and increase the capacity of the system. Energy bills have also risen sharply, by 9.4% in the last year and have yet to reflect a decline of over 20% in wholesale gas prices in the last year. Meanwhile the government has added to the upward pressure on prices by raising vehicle excise duty by over 8% in April and tobacco duty by 6.4% in last year’s budget.

Strong wage growth has compounded the UK’s inflation problem. In the year to June average weekly earnings rose by 4.6% while output per hour worked fell by 0.8%. The UK labour market data have been plagued with problems since the pandemic, but, on the face of it, employers are paying more for less output.

In a speech in October the Bank of England’s chief economist, Huw Pill, suggested that structural changes, including rising levels of sickness and disability, may have reduced the flexibility of the labour market and have fuelled wage pressures. What is clear is that government policy has played a part, with the minimum wage rising by 6.7% in April and employers facing sharply higher national insurance contributions.

A higher minimum wage and rising national insurance contributions have had a pronounced impact on sectors that employ lower-paid workers, with, for instance, higher costs feeding into prices in restaurants and cafes.

The good news is that UK inflation has probably peaked and is likely to decline in the coming months.

A period of slower growth in water and energy prices is in prospect. Last week the chancellor said one of her three key aims for the budget was to ease cost-of-living pressures, a statement that seems to preclude the sort of outsize increases in taxes that were seen in April.

A weakening labour market is likely to weigh increasingly on wage growth, dampening this source of inflationary pressure.

The Bank thinks that the persistent inflation of recent years can be broken. It sees inflation dropping over the coming months and running around the 2.5% mark in a year’s time. One hopes that this forecast will prove more accurate than the one the Bank made this time last year.