Why falling inflation masks some nasty surprises

Another interest rate rise is coming, to 4.75 per cent – and it may not be the last, writes James Moore

Food prices remain a blackspot as inflation overshot most forecasts (PA)

Well, we’re finally out of double figures. The headline Consumer Prices Index (CPI) rate of inflation for April came in at 8.7 per cent against 10.1 per cent in March.

It’s a steep fall, but a lot less steep than most had hoped or expected; a Reuters poll of economists predicted 8.2 per cent, while the Bank of England’s more conservative forecast was 8.4 per cent.

Set against those numbers, that result represents a substantial overshoot, especially when you consider that energy – the principal cause of the worldwide inflationary spike – is now playing less of a role, with bills expected to ease compared to last year.

Food prices are picking up the slack, remaining stubbornly high; the official figure came in at 19.1 per cent, barely changed on the previous month’s 19.2 per cent despite the fuss supermarkets have been making about cutting the price of some essentials.

Equally as worrying will be the performance of core inflation, which excludes volatile components such as food and energy. A measure of the underlying inflation in the economy, the expectation was that it would stay flat at 6.2 per cent. Instead, it increased, and sharply, to 6.8 per cent.

A jack-in-the-box of the worst possible kind, it could be argued that it points an accusatory finger in the direction of the Bank of England’s rate-setting Monetary Policy Committee (MPC), with the exception of its most hawkish member Catherine Mann, who has previously voted for harsher medicine than her colleagues have been willing to administer.

Inconveniently appearing before the treasury committee yesterday, governor Andrew Bailey had to admit that Threadneedle Street’s economic model has proved inaccurate. Some of the pressure Bailey is now under is motivated by the cynicism of Tory MPs, who find him a convenient target to divert attention from their party’s economic record.

But while it is obviously easy to criticise with the benefit of hindsight, some of the brickbats aimed at Bailey look justified. It isn’t so much that the Bank didn’t see the inflation dam breaking, but rather that the MPC was too slow to halt the flow.

Jeremy Hunt said: “The IMF said yesterday we’ve acted decisively to tackle inflation but, although it is positive that it is now in single digits, food prices are still rising too fast… we must stick resolutely to the plan to get inflation down.”

That plan is now going to involve more pain because numbers like this are creating pain for the Treasury. Markets are now expecting a higher peak for interest rates, which had an immediate impact on the bond markets on Wednesday. UK government borrowing, already starting to overshoot forecasts, is getting more expensive still.

Interest rates take time to have an impact, but so far there are too few signs that they are high enough to sustainably bring prices down. That’s bad news for small businesses, for whom securing affordable credit is becoming an increasingly pressing issue.

Institute of Directors chief economist Kitty Ussher said: “Policymakers will hope that now that the headline rate is back to single digits, expectations of future inflation will now start to fall as well, which then could become self-fulfilling.” The trouble is, policymakers have to date been over-reliant on hope.

We are nearly a month out from the next MPC meeting, on 22 June. Its members are in a difficult spot, but with projections for the UK economy notably improving, I expect they will bite the bullet. Another rate rise coming, most likely 4.75 per cent; and I don’t believe it will be the last.

Tough medicine but necessary. As a Twitter user observed on the ONS inflation thread: “We’ve slowed down from 101 mph to 87 mph. It’s slower, but we’re still nowhere near safe.” Time for the MPC to slam on the brakes.