Gyrations in the oil market meant it was a stone-cold certainty that inflation would be on the rise in late 2016. This time last year the price of crude was crashing, which put strong downward pressure on the cost of living. The annual inflation rate is the sum of price movements in the latest 12 months, so last year’s price falls are gradually dropping out. As they do, inflation automatically goes up.
This trend is, however, is being amplified by two other factors. The first is that oil prices are not just holding steady: as a result of the deal between oil-producing countries to curb production they are going up. A year ago, it was possible to find unleaded petrol at around £1 a litre; this Christmas it will be £1.20 a litre.
The second factor is the 15% depreciation of the pound since the EU referendum in June. Although sterling has been edging higher for the past month, the lagged effect of its drop during the summer and early autumn is making imports dearer. A pick-up in producer price inflation – the cost of goods leaving factory gates – is early evidence of this effect.
At 1.2%, inflation remains below the government’s 2% target but it will not remain there for long. Prices fell by 0.8% in January 2016 and unless that fall is replicated next month (which it won’t be), inflation will rise. It is likely to hit 2% by the spring and 3% by the end of the year, unless the price-fixing deal for oil falls apart and the cost of crude comes crashing down again.
Historically, an inflation rate of 2% to 3% is relatively modest for the UK. It will still be enough, however, to put a pronounced squeeze on living standards next year, because prices are going to rise faster than wages.
