Why is UK inflation so high?

Why is UK inflation so high?

The UK seems to have an inflation problem. In the last 12 months, prices rose by 3.8% in the UK, faster than in any G7 or western European nation.

• This isn’t a new problem. The UK has been running higher inflation than the other major industrialised countries for most of the last four years.

• It wasn’t supposed to be like this. A year ago the Bank of England expected inflation today to be running at 2.8%, not 3.8%.

• 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.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.7% at 9,682.

Economics

• The Nasdaq ended the week down 4%, losing over $1tn in market capitalisation, amid investor worries over the high valuations of large artificial intelligence stocks
• The US government shutdown is now the longest on record. Fears are growing of the negative impact on the US economy as federal employees’ incomes are squeezed, payment of benefits is disrupted and flights are cancelled due to a shortage of air traffic controllers who are not being paid
• In the absence of official US economic data, investors are closely following unofficial estimates of activity. Figures from payroll processor ADP suggest that the private sector added 42,000 jobs in October, a return to growth after contractions in the two preceding months
• UK chancellor Rachel Reeves refused to rule out tax rises in the Budget later this month, fuelling speculation that she is preparing to raise rates of income tax
• The Bank of England kept interest rates on hold at 4% in a tight decision that saw four of nine policy makers vote for a cut to 3.75%
• The average price of a house in the UK rose by 0.6% from September to October to a record high of £299,862, according to estimates from Halifax
• UK construction activity contracted at its fastest pace in over five years in October, according to estimates from surveys of purchasing managers, amid regulatory uncertainty
• Chinese exports in October were down 1.1% from the same month last year, the first such fall since February
• Canadian prime minister Mark Carney unveiled a budget that includes a sharp rise in borrowing to offset the economic effects of US tariffs and boost defence spending

Business

• The FT reports that US companies’ earnings are growing at the fastest rate in four years, defying fears that president Donald Trump’s policies would hit profits
• Nvidia chief executive Jensen Huang warned that China was going to beat the US in “the AI race”, due to higher energy prices and more stringent regulations in the US
• The EU said it was considering changes to its artificial intelligence law that passed last year amid concerns that stricter regulation than the US was discouraging investment
• Tesla shareholders approved an agreement that would see chief executive Elon Musk receive up to $1tn in compensation if he meets stretching targets including a valuation of $8.5tn and operating a million robotaxis
• UK broadcaster ITV is in talks to sell its television business to Sky. Any potential deal may attract the attention of the competition regulator
• Chinese exports of cars rose 23% last year to 6.4m vehicles, 50% more than were exported by Japan, the world’s second-largest car exporter
• Norway has suspended its ethical investment rules to allow its sovereign wealth fund to continue to invest in Amazon, Alphabet and Microsoft despite their work for the Israeli government
• US drugmaker Eli Lilly said that European governments should pay more for drugs or risk losing access to new treatments
• US corporate earnings at listed companies grew 11% in the third quarter relative to the same period last year, the fastest rate of growth in four years

Global and political developments

• BBC director general Tim Davie and the corporation’s head of news resigned over allegations of bias in its news coverage
• The 30th session of the climate conference, COP30, opens on Monday in the Amazon region of Brazil
• Russian forces appear to be strengthening their positions in the city of Pokrovsk, raising fears that this strategically important hub is close to falling
• The EU is pressing for the UK to make a financial contribution in return for an agreement on checks on plant and animal exports and energy trading, the FT reports. Norway and Switzerland already make similar contributions
• A third Chinese aircraft carrier entered service with a fourth under construction, highlighting the growing military power of the world’s second-largest economy
• The UK is sending a specialist RAF counter-drone unit to Belgium after repeated suspected Russian drone incursions above the country’s airports and military bases
• The US Democratic Party won New York mayoral and two state governor elections amid low approval ratings for president Donald Trump
• The EU reportedly failed to find a deal with Belgium to use frozen Russian assets to finance a €140bn loan to Ukraine amid concerns over the state of Kyiv’s finances
• The FT reports that following a Norwegian investigation that found that buses made by China’s Yutong, the world’s biggest bus maker, can be switched off remotely, the UK government is investigating Chinese-made electric buses in the UK for similar vulnerabilities

And finally… China’s space programme claimed a culinary first after successfully barbecuing chicken wings in a specially adapted air fryer aboard the Tiangong space station – stellar cuisine