Inflation pressures set to remain says Ernst & Young ITEM Club

PERSISTENTLY high inflation has knocked almost 3% off UK growth over the last three years and is set to remain above the Chancellor’s target for the foreseeable future, according to the Ernst & Young ITEM Club.
 
In a special report released today, the Ernst & Young ITEM Club says that had inflation averaged 2% over the last three years – rather than 3.5% – UK GDP would now be more than £10bn higher.
 
The report suggests that inflationary pressures will peak over the summer, while a strengthening UK and global economy is unlikely to see inflation dip below 2.5% over the next four years.

Carl Astorri, senior economic advisor to the Ernst & Young ITEM Club, comments: “High inflation has had a corrosive impact on the UK economy over the last three years, eating into household spending power which has taken its toll on the high street. Food prices have soared by nearly 40% since 2007, while businesses and consumers have also had to endure the impact of rising oil and commodity prices, a weakening pound, plus hikes to VAT and tuition fees.

“But it could have been worse. Our modelling shows the MPC were right to stick to their guns, allowing inflation to overshoot and avoid tightening monetary policy. The alternative scenario would have seen interest rates rise by 3.5% in 2011, choking off the recovery even earlier and adding an additional 625,000 people to UK dole queues.”

The Ernst & Young ITEM Club says CPI inflation will hit 3% over the summer but, with domestic energy bills and food prices set to rise less than last year, will ease back to 2.5% by the autumn.
 
In the absence of any escalation in political tensions in the Middle East, the report expects prices at the petrol pumps to stabilise at around 135p per litre this year. After the sharp rise last summer, wheat and corn prices will continue to drop back, providing there are no unexpected weather related disruptions.

“Don’t expect to see a return to the so called NICE decade of low and stable inflation,” warns Mr Astorri. “One of Mervyn King’s last acts as Bank of England Governor will almost certainly be a letter of explanation to the Chancellor to explain yet another inflation overshoot. And further out it’s unlikely that the UK will get back to the Chancellor’s 2% target.”
 
The report says that even once temporary factors – such as the rise in tuition fees – have fed through the system, underlying inflationary pressures will have started to build again. As the UK economic recovery continues to strengthen, workers will have greater bargaining power to push for wage increases while businesses will be in a better position to grow their profit margins with price hikes. Rising import prices from the emerging markets are also set to continue, driven by increasing labour costs as their economies mature.
 
The Ernst & Young ITEM Club is forecasting CPI inflation rates of 2.9% in 2013, before settling at 2.6% in 2014 and 2015.

Mark Gregory, Ernst & Young’s chief economist, says higher inflation will impact profitability if business does not respond effectively. “It is critical for businesses to develop a detailed understanding of the likely impact on consumer spending and the future costs of supply to help shape its strategic response. Pricing will be key and businesses must consider acting to increase the average prices paid for their goods and services.”