Rishi Sunak has vowed to cut the headline rate of inflation “in half by the end of the year”. The Prime Minister’s “five pledges” speech earlier this month laid out a series of promises – on the economy, NHS waiting lists and immigration.
The inflation pledge received most attention, with soaring prices and the related cost of living crisis dominating UK politics.
Yet Sunak’s vow to halve inflation by the end of the year was about as ambitious as predicting, in early January, there will be more sunshine in June. I exaggerate, but not a lot.
Already high at the start of 2022, inflation surged last year to a 41-year high. Last January, the Consumer Price Index was 5.2pc higher than the same month in 2021 – way above the Bank of England’s 2pc target. By October, headline inflation was 11.1pc – with prices for food, fuel and many other necessities rising at an even faster pace.
In November, inflation eased to 10.7pc – and is expected to fall more when the December figure is released on Wednesday. Crucially, though, the Office for Budget Responsibility, not known for its optimism, predicts UK inflation falling to 3.8pc by the end of 2023. That’s still high – but way below the 5.3pc it would need to be for Sunak to meet his pledge.
The reality is that inflation is almost certain to come down sharply over the course of this year, as the high price rises of 2022 effectively drop out of the annual numbers. Widely understood across financial markets, this notion is yet to land with much of the media and the broader public – which is why Sunak can get away with making easy promises.
In the US, which releases official data earlier than Britain, CPI inflation dropped to 6.5pc in December, sharply down from 7.1pc the previous month. That’s the sixth successive monthly decrease, with inflation hitting a 14-month low, entrenching the notion that price pressures in the world’s largest economy have peaked.
As much of the world emerged from lockdown in late-2021, pent-up demand surged in late 2021 but ongoing supply chain blockages caused prices everywhere to spike. The latest US data shows such blockages starting to ease – pushing down prices for everyday items such as clothes and appliances.
December’s inflation drop also stemmed from a steep fall in petrol prices and other fuel costs. Oil prices in the US last month, averaging around $75 a barrel, were similar to December 2021 – removing a major inflation driver. The same trends are apparent here in the UK, as we also begin to benefit from port and shipping bottlenecks easing around the world, with fuel inflation also starting to abate.
War in Ukraine and reduced Western imports of Russian gas, in particular, clearly pushed up wholesale energy prices everywhere last year, aggravating post-lockdown inflationary pressures. But European wholesale gas – at around €63 per megawatt hour – is now cheaper than before Putin invaded Russia, with prices some 60pc lower than in December, and 80pc down on their mid-summer peak.
Yes, wholesale gas is still three times more expensive than during the years before lockdown. But inflation measures changes in price levels, not the levels themselves. So fuel prices will – throughout 2023 – exert serious downward pressure on the headline CPI number, helping Sunak meet his pledge.
One of the few reasons this scenario might fail to materialise would be a massive escalation in conflict between Russia and the West, sparking far more serious fuel restrictions and even blockades, causing energy prices to spike anew. But if that happens, Sunak could obviously blame Putin. That’s another reason why his inflation pledge is politically shrewd, but not really a pledge at all.
Here in Britain, I suspect consumers will soon start to be faced with energy bills that are considerably lower than was previously feared, as wholesale gas and electricity wholesale prices continue to tumble, in part due to a mild European winter.
The investment firm Investec reckons average energy bills will drop from £3,317 from April to £2,478 from July, before rising slightly to £2,546 from October due to seasonal factors – way below the current £3,000 annual price cap. These domestic energy costs are still sky-high, of course – back in October 2021, the average was just £1,277.
But just months ago, we were being warned about average annual utility bills exceeding £5,000 or even £6,000. That now seems outlandish. And as energy prices drop, the Government’s finances could be boosted to the tune of double-digit billions, as the massive cost of household energy subsidies tumbles. While Sunak is cash-strapped for now, that could soon start to change.
If energy bills don’t start falling soon for customers, reflecting lower wholesale prices, then industry regulator Ofgem should be taking a very close look at what the energy providers are up to.
Many businesses are also concerned, understandably, that government support for companies’ energy costs is to be drastically reduced, as the Treasury confirmed last week. Ministers need to understand that if wholesale price falls aren’t passed on to commercial energy users, many firms will fold as support is withdrawn. The bigger picture, though, is that lower fuel costs throughout this year are likely to help drag down the headline inflation rate – helping Sunak to meet his pledge.
As headline inflation has eased in the US, so have interest rate expectations. The Federal Reserve implemented four 0.75 percentage point rate rises last year, moving decisively to tame inflation. But as the monthly CPI measure fell, there was just a half-point rise in December – and we could see just a quarter-point increase at the end of this month.
The Monetary Policy Committee, which has its next rate-setting meeting in early February, may well take a similar view. The economy unexpectedly grew in November, with GDP up 0.1pc on the previous month, boosting hopes the UK might yet avoid recession. And if inflationary pressures continue to ease, UK interest rates, having risen sharply from 0.25pc to 3.5pc during 2022, may not have that much further to rise.
The conventional wisdom is that the Tories are doomed – certain to lose the next election. But if the price squeeze eases, and the economy starts looking up, a political reversal can’t be ruled out.
Rishi Sunak is likely to fulfil his pledge to halve inflation this year
The prime minister's promise is not as ambitious as it sounds