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CPI hits highest level on record

Laith Khalaf, Head of Investment Analysis, AJ Bell

Laith Khalaf, head of investment analysis at AJ Bell, comments on the latest inflation figures from the ONS:

“Inflation is going to pile serious pressure on UK households in the next few months, particularly when combined with the tax rises the Chancellor has planned for April. The main issue is that price rises are being most keenly felt in energy and transport, areas where expenditure is unavoidable, and which constitutes a bigger slice of the budgets of those on lower incomes.

“CPI now stands at 5.4%, the highest annual reading since this measure of inflation was introduced in 1997, though significantly higher price rises were recorded in the 1970s, 80s and early 90s, when the now largely retired RPI measure was used. It will be little comfort to those feeling the pinch of price rises today, but looking over a slightly longer period, CPI inflation has risen by 6% over the last two years. That’s only slightly more than it has increased over one year, thanks to the deflationary effects of the pandemic in 2020, which saw some oil contracts trading in negative territory, and tells us just how sharply prices increased over the course of 2021.

“The annualised nature of the inflation calculation suggests this spike may recede if commodity prices fall back towards the end of this year, or indeed simply fail to keep rising. Whether that will happen will continue to depend on Russia, OPEC and supply chain disruption. But commodity prices are cyclical, and as the saying goes, the cure for high oil prices is high oil prices.

“Probably a greater threat in creating sustained inflation comes from the labour market. A record level of vacancies, combined with a hefty increase in the National Minimum Wage could give a wage price spiral a bit of momentum, taking root first within companies, and then manifesting itself in consumer prices. It was telling that the high street retailer Next has just warned the market that it faces 5.4% wage inflation this year, and when added to elevated shipping costs, that means item prices are expected to rise by 6%. If this sort of thing is happening across the economy, the risk is that inflation becomes embedded in the expectations of business and consumers, at which point it becomes much more sticky.

“The Bank of England has of course raised base rate back to 0.25%, but that still means that cash savers saw their money lose 5% of its buying power in 2021. The coming year isn’t shaping up to be much better, because the pace at which interest rates rise will only negligibly take the edge off inflation. The market is now expecting in another rate hike in February, but as we’ve often seen, the Bank doesn’t always follow the script laid down by market prices.”

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