Inflation is softening:
Yesterday CPI came in at 10.1%, lower than the consensus estimate of 10.3%.
The numbers are now starting to look really soft. Month-on month, CPI fell by 0.6% and core inflation prints are starting to drop very sharply.
CPI excluding energy, food and alcohol:
CPI excluding housing, energy and water:
CPI services:
With all of these, the 3 month annualised inflation rates are pretty much back to pre-inflation levels. Of course it’s only 3 months of data, but if we are experiencing a rapid disinflation, this is what it would look like.
Changing Weights
The latest CPI data includes new weights, taking account of changes in expenditures. There are two main changes:
First, and unsurprisingly, the weights on energy and transport have gone up as they have become a larger part of total expenditure.
Second, expenditure on activities that have restarted after COVID have seen their weightings increase. So this is things like restaurants, hotels and holidays with the weightings on things that were popular during lockdowns like alcohol and audio-visual services now falling. There is also a big drop in the weight on actual rents. This might be a result of the saving ratio decreasing after lockdowns mechanically making it a smaller part of expenditures.
With energy and transport now having larger weights, the 12 month inflation figures may be bumped up a little at the beginning of the year, but assuming these prices continue to fall as wholesale energy prices fall, this weight change should help bring inflation further down towards the end of the year.
Model Outputs
Last month I posted outputs from my CPI model. You can see the full assumptions behind the model here:
I’ve updated the weights and rerun the model using the latest inflation data. I’ve also made a couple of changes to assumptions about energy prices:
Reasonable Best Case
Energy price cap stays at £2,500 through April-June instead of going to £3,000. From July, the cap then falls to £2,300. (Cornwall Insight suggests that prices will fall to £2,400 but as a best case, I’m assuming a further fall).
Here you can see inflation falling to 1% in December this year.
Reasonable Worst Case
Energy price cap rises to £3,000 through April-June as planned. From July, the cap then falls to £2,800. This is subjective, but only a month ago, based on the future natural gas price curve, this was the projection. So lets assume prices rise again to this level:
The combination of a slightly lower energy price forecast and higher weightings on energy help bring this forecast down, with the reasonable worst case now suggesting inflation ending the year at 4.4%.
How this forecast compares to the consensus
The midpoint of my end of year forecast is now 2.7% compared to 3.85% last month.:
The average of the latest forecasts collated by the Treasury is 4.2%. This is more in line with my upper bound. A lot of the differences are likely to come down to assumptions about (i) government policy on price caps and (ii) the wholesale price of energy over the next 10 months.