Inflation falls to 4.6% - but lags behind the rest of the world

The latest UK inflation figures are out and at last the nation can take a breath as headline inflation plunged to 4.6% in the 12 months to October, down from 6.7% in August and September. This is in part due to the new lower energy price cap which came into effect at the start of October, reducing the amount being spent on heating bills.

The sharp decline came as a surprise to economists. A drop was widely predicted, however such a significant fall after a few months of relative stagnation was unexpected. 

Core inflation, which strips out food and energy prices in its calculations, fell more slowly to 5.7%. Even so, 5.7% was the lowest core inflation level recorded since March 2022.

The Bank of England hiked interest rates 14 times in a row in order to bring inflation down and under more control but held interest rates for the past two months as this objective looked like it was being achieved.  Although down to actions of the Bank of England, it is thought to be a key victory for Rishi Sunak in the lead up to the election and gives a strong indication that the Bank of England may not need to make any further base rate hikes. 

What is inflation and how is it measured?

Inflation is a measure of how the prices of goods and services have increased over time. 

Goods are tangible items sold to customers, such as food, while services are tasks performed for the benefit of recipients, such as haircuts or train tickets. Generally, this increase is measured by considering the cost of things today compared to how much they cost a year ago. The average increase between these prices is demonstrated in the inflation rate. 

Rising interest rates directly affect the cost of living. For example, if the price of a bottle of milk is £1, and inflation is increasing by 5%, then your bottle of milk will cost you 5p more. Or, in other words, the spending power of your money has decreased by 5%. 

Ideally, the Government wants to keep inflation low and stable. The general mandated target for the Bank of England is 2%. Anything significantly above or below this target is thought to cause issues for the economy. 

Inflation on the global stage

One thing we can be sure of is that inflation is easing globally from the highs reached in many countries following the COVID pandemic and then Russia’s invasion of Ukraine. 

Despite this, it’s been clear that the UK economy has been lagging behind. Even with the unexpectedly large drop in October, UK inflation still hovers above the US, Japan, China and Europe. There are a number of factors that have contributed to this, for example the UK being a ‘service based’ economy, with wage costs keeping inflation higher for longer. 

Figure - 1 Annual % change in consumer price index 

Another important factor to consider is that inflation expectations have begun to fall, which you can see in the inflation swap market graph below, which indicates what markets believe will happen to interest rates and inflation over time. The five-year expectation of inflation in the UK, US, Germany, France and the broader Eurozone have fallen from their peaks of last year.

Figure 2 - Market expectations of average inflation over the next five years * (%)

This is particularly important because inflation expectations can have a real impact on inflation itself. 

For example, central banks will be looking to monitor and adapt things such as interest rates ahead of inflation in order to keep the economy under control. The Bank of England has to strike a careful balance between controlling inflation and not creating too deep of a recession through higher interest rates. 

Another example is that workers often demand higher wages to tackle higher inflation, but then these higher wages can lead to continued spending which inevitably adds to inflationary pressure, leading to an upwards spiral of wage hikes and rising cost of goods. This is why inflation expectations are almost as important as inflation itself – they often dictate what consumers experience in real terms.

With headline inflation still well above target of 2% and interest rates uncertain, it’s more important than ever to make sure your finances are handled responsibly and with the right guidance. That said the better than expected inflation news out today again signals that we are possibly at the top of the current interest rate cycle and there's no indication that the base rate will start to fall anytime soon.

At The Private Office, we understand the stress surrounding the current economic climate. Our chartered financial planners are unbiased, meaning that they can give whole of market advice, and so are best placed to give you a plan tailored exactly to your personal financial goals.

If you’d like to know more, request a free non-committal initial consultation with one of our team or give us a call on 0333 323 9065 and get in touch.

*Sources: Refinitiv; ICAP (UK data not directly comparable as linked to the retail price index rather than the consumer price index)

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