Why is UK inflation so high?

Inflation figures are a strange concept since they seek to measure how much prices have changed in the past year. As such, any price rises fall out of inflation figures after 12 months.

European inflation appears to have recently peaked as energy price rises fall out of calculations. Meanwhile, in the US, which generates a lot of its own energy and so is less affected by commodity price rises, inflation figures peaked several months ago. Instead, price rises that are currently causing higher than desirable inflation are secondary effects such as higher wage demands. These tend to be described as core inflation.

Then we turn to the UK, where inflation can be best described as plateauing. Even though energy price rises are dropping out of inflation, other price rises are keeping inflation above 10% for now.

Brexit has certainly been an issue, as a scarcity of workers (research from the Centre for European Reform and the UK in a Changing Europe suggests there are 330,000 fewer workers in the UK due to Brexit) is helping to drive employee wage demands and added trade frictions make importing goods more costly.

In the most recent inflation reading, unseasonably poor weather in Europe and North Africa, which affected the price of vegetables, was cited as a prime driver of a surprisingly high reading. However this will have been a significant issue in Europe where inflation is falling, so we have to ask ourselves: is the UK structurally more susceptible to high inflation than other developed economies?

Take for example that US inflation figures account for higher interest rates in the shelter part of the calculation. In the UK this is not included. Further, US shelter is a larger percentage of the CPI basket at 44% vs 26% in the UK. So if calculations were like-for-like, the UK would likely be measuring an even higher inflation differential vs the US. One caveat here is that US mortgages are often fixed for 30 years, so recent rate rises are taking a long time to feed into inflation calculations.

Given the available evidence points to elevated UK inflation, we are more nervous than we perhaps would have been about adding duration (interest rate risk) to portfolios, as the Bank of England is likely to need to keep interest rates higher for longer. 

James Rowlinson, Senior Investment Governance Manager