The sharp rise in CPI inflation from +0.6% to +1.0% came as a bit of a surprise, but it is unlikely to mark the start of an upward trend. CPI inflation still looks on track to fall to within a whisker of zero in August.
Inflation still set to fall close to zero, despite July jump
- The sharp rise in CPI inflation from +0.6% to +1.0% came as a bit of a surprise, but it is unlikely to mark the start of an upward trend. CPI inflation still looks on track to fall to within a whisker of zero in August.
- The jump in inflation from +0.6% in June to +1.0% in July (consensus forecast +0.6%), was partly due to the rise in global oil prices, which pushed fuel price inflation up from -16.4% to -12.0%. (See Table 1.) But the core measure (ex. food, energy and tobacco) also picked up from +1.4% to +1.8% (consensus +1.3%). That was driven by a rise in inflation in all major core categories. The increase in clothing inflation (from -2.2% to 0.0%) and furniture inflation (from +0.5% to +1.5%) made the largest contributions. In addition, there was some early evidence that in some areas, such as hairdressing, firms have passed on the higher cost of coronavirus requirements to consumers by raising their prices.
- Some of these movements should be at least partially reversed over the coming months. The +0.13ppt boost to CPI inflation from the clothing category appears to have been due to a delay to this year’s summer sale season. But as pent-up demand fades, we suspect that retailers may need to do more to entice people through the doors in the coming months. So this clothing effect will probably be reversed in August, assuming that the sales then take place. Meanwhile, food price inflation (which slipped from +1.0% in June to +0.7% in July) is likely to continue to fall back as the re-opening of restaurants and cafes leads to fading demand for supermarket food.
- What’s more, in August, the effects of the cut in the VAT rate for hospitality/tourism on 15th July (prices were collected on 14th July so this won’t be captured until August’s data) and August’s “Eat Out to Help Out” (EOHO) restaurant discount scheme will kick in. We assume that 50% of eligible businesses pass on the VAT cut and 50% participate in the EOHO scheme, prompting inflation to fall by 0.7ppts. But if the pass-through of both the VAT cut and the EOHO scheme is 75% rather than 50%, then inflation may fall by 1.1ppts.
- Either way, that would be enough to push inflation close to zero in August. And we think it will be a few years before the economy is strong enough to raise CPI inflation to the 2% target. (See Chart 1.)
Chart 1: CPI Inflation (%)
Sources: Refinitiv, Capital Economics
Table 1: Consumer Prices
Core % y/y
Fuel % y/y
Food % y/y
Ruth Gregory, Senior UK Economist, +44 7747 466 451, firstname.lastname@example.org