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UK Economy - What is Causing the Steep Fall in Inflation?

Geoff Riley

16th November 2023

This short video explains three reasons for the steep fall in UK inflation.

UK Economy - What is Causing the Steep Fall in Inflation?
  1. Inflation Overview:
    • Steep increase in UK inflation in 2021-22, peaking at over 11%, leading to a cost of living crisis.
    • Comparable rise in inflation in the United States, Euro Zone, and Japan, with China edging closer to deflation.
  2. Factors Contributing to Inflation Decline:
    • Energy Price Cap Cut: Significant fall in UK inflation due to a major cut in the energy price cap set by Ofgem, reducing the unit cost per kilowatt-hour.
    • Global Energy Prices: IMF Global energy price index shows a sustained decline in global energy prices, though still higher than pre-pandemic levels.
    • Food Price Inflation Decline: A decrease in the rate of food price inflation from 19.2% in spring to 10% in October 2023, impacting the overall cost of living.
    • Used Car Market Influence: Used Car Price Decline: Notable deflation in the UK's used car market, with a 4.2% drop in October 2023, potentially influenced by rising car insurance premiums.
  3. Government and Bank of England's Response:
    • Disinflation in the UK: Despite government claims, the causes of disinflation are largely external, driven by falls in world energy and food prices.
    • Interest Rate Impact: Bank of England's sustained interest rate increases to 5.25% in response to disinflation, limiting aggregate demand and economic growth.
  4. Outlook and Policy Implications:
    • Inflation Target and Interest Rates: Inflation remains well above the 2% target, suggesting a need for ongoing Bank of England intervention. The recent data on falling inflation may indicate a peak in interest rates, with a possibility of plateauing or even a decline in the future.

You've got to love Paul Johnson of the IFS: not only does he lead an influential think-tank but he's also pleasing direct in his analysis, as this BBC article shows.

His answer to the question is unequivocally 'No' - not only was the pledge to halve inflation by the end of the year disingenuous, "given the fact that Bank was, in January, forecasting that inflation would easily halve", mainly for reasons beyond either the government or the Bank of England's control. That said, he also points out that freezing income tax personal allowances increased tax revenues and will have played some part in reining in spending.

He even argues that the government shouldn't have made the pledge on the grounds that it's no longer responsible for hitting the inflation target and that in doing so, it was in danger of muddying the waters surrounding the issue, potentially compromising central bank independence.

Geoff Riley

Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.

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