Commentary Directory

UK CPI: Energy Inflation Crashes but Services Inflation is Still Sticky

Jacob Hess
August 16, 2023

UK CPI grew 0.4% MoM and 6.8% YoY in July, down from 7.9% YoY in June. The decline in the headline annual rate can be attributed almost entirely to falling gas and electricity prices which had been the main source of the cost-of-living crisis that has developed over the last two years. The energy index fell -9.5% MoM last month which caused the annual rate to turn sharply negative at -7.8% YoY in July (down from 3.2% YoY in June). Normally, elevated food costs would offset the decline in energy, but in the last few months, inflationary pressure from food has eased. Food price growth was just 0.2% MoM increase, and YoY food inflation fell to the lowest point since the beginning of the year at 13.2% YoY. These trends in the volatile categories has led CPI inflation to the lowest since February 2022.

From ONS

A different story is told by core CPI inflation. YoY core CPI growth was 6.9% YoY in July, unchanged from 6.9% YoY in June. This is near its high of 7.1% YoY and about half a percentage point to a percentage point higher than the range in 2022. The services index continues to keep core inflation sticky. Services inflation was 7.4% YoY, up slightly from 7.2% YoY previously. In July, hotels and air travel were the largest upward contributors. Travel & transport services inflation jumped to 10.6% YoY, a new peak, and the index tracking package holidays and accommodation services was 12.1% YoY. On the core side, durable goods prices are the main source of disinflation at -1.3% MoM and the annual rate falling -0.9 ppts to 3.9% YoY, the lowest of the notable goods type aggregates.

A similar story is told by the PPI report released today. Oil and petroleum inputs caused both input and output PPI growth to fall deeper into negative territory. Input prices were down -0.4% MoM and -3.3% YoY, and output prices were up slightly by 0.1% MoM but down -0.8% YoY. Notably, the annual inflation rate of the output PPI was negative for the first time since December 2020. This is the twelfth consecutive month that the annual inflation rate has slowed. However, the cause of that decline can be traced back to the sharp -40.0% YoY decline in petroleum product output prices.

The substantial decline in headline CPI inflation is a strong positive for UK consumers. Out of all the developed economies, UK households have felt the most hard done by inflation due to the sharp energy shock. That shock does seem to be over for the most part. Outside of the easing there, inflation has not abated with the exception of the durable goods category. Services inflation is the main talking point and is the main reason for sticky core CPI inflation due to the concentration of consumer demand in the services sector. Despite higher costs, consumers are not giving up on travel plans which suggests a lot about the strength of household financial conditions despite higher interest rates.

From ONS

The Bank of England has largely expected services inflation to maintain its pace, saying in the most recent Monetary Policy Report that “services CPI inflation was projected to remain broadly unchanged in the near term.” However, any ticks upward will likely be met with similar upticks in the BoE’s hawkish rhetoric. The new near term peak in wage growth (up 7.8% YoY in Q2 2023, the highest since 2001) is also something that BoE members will consider in assessing the stickiness of services inflation. With that being said, if they decide that core CPI is the problem that needs to be solves, another rate hike is likely coming in the next meeting in September.

From Econ Mornings