UK inflation appears to be stabilising. However, underneath the surface, the dynamics remain complex and uncertain. Businesses that learn the lessons of the past and invest in foresight capabilities can build confidence for the future.
Inflation is back to its long-term average
After hitting a peak of 11.1% in October 2022, inflation appears to be stabilising. In August 2024, the annual rise in UK’s consumer price index (CPI) was 2.2% – only somewhat above the historical average of 2.0% in the two decades to 2019. Most economic forecasters now expect CPI inflation to stay relatively close to the Bank of England’s 2.0% target for the next 18 months or so. Implicit in those projections is a gradual easing of the monetary policy stance, with financial markets expecting the Bank of England to reduce the bank rate from 5.0% in September 2024 to around 3.5% by December 2025. The downward trend is also starting to be reflected in mortgage rates.
Following the rollercoaster ride of the last two years, this projected stability may appear optimistic. Indeed, the current inflation picture is far from certain, and while the level of inflation is back to its historical average, its composition is quite different from the pre-pandemic norm (Exhibit 1). In August 2024, overall inflation was still being pulled down by nearly 1 full percentage point by energy prices, largely on account of reductions in households' electricity and gas bills. However, over time this effect is likely to fade.
Moreover, like other geographies, the UK has experienced sticky services inflation. Prices of all consumer services increased by 5.6% between August 2023 and 2024, and inflation contributions from hospitality and recreation, housing (mainly rentals), and other services (e.g., education, air fares, and telecoms) were considerably higher than in 2018-19. Some of these price increases will probably abate as wage growth slows down, which looks likely as the labour market cools and inflation expectations moderate.
Overall, it therefore looks that inflation in the near term might average out at a moderate level. However, the last few years have demonstrated that there is no room for complacency; and that aggregate inflation figures diverge considerably from those experienced by specific individuals and businesses.
Global shocks created pervasive domestic price pressures
The detailed origins of the recent episode of high inflation are hotly debated. Nevertheless, few would argue that COVID-19 and the war in Ukraine had nothing to do with it along with other factors. Certainly, in the UK, the early phases of this cycle were dominated by imported inflation, indicating that price rises experienced by UK consumers had a significant global element to them. At the peak in October 2022, 70% of UK’s inflation came from import-intensive goods or energy, for which prices tend to be set in international markets.
The pandemic had disrupted value chains across the world, building pent-up demand for goods and increasing businesses’ costs of sourcing raw materials and components. And while global energy prices had already been increasing in the run-up to the war in Ukraine, in 2022 European oil and gas prices spiked at 2 and 12 times their recent average (from 2015 to 2019), respectively. The higher natural gas prices, in particular, contributed to significantly higher fertiliser and food prices, fuelling broader inflation in global commodities.
However, since mid-2022, commodity prices have been broadly on a downward trend. Given that inflation is measured as a year-on-year increase in prices, a high but stable price should equal zero inflation after 12 months. Declining prices should, then, result in negative inflation. So how come the UK’s consumer inflation has remained high until very recently? The simple answer is time-lags: it took time for commodity price increases to filter through to consumer prices, and the same is true on the way down. A more complex reason comes from the dynamics between global and domestically generated inflation.
As the cost of consumers’ purchases—for imported goods, energy, and food—increased, so did workers’ demands for pay rises. One of the pandemic’s after-effects was a very tight labour market, where such asks had more sway, pushing up wage growth. This process, too, took some time, but in the three months to July 2023, average weekly earnings grew by 8.5% per annum, at 4 times the pre-pandemic average. Higher wages resulted in higher costs, especially for labour-intensive services such as hospitality, cultural services (e.g., theatre and concerts), and personal services (e.g., hairdressing), with further pressure to put up consumer prices.
The different waves of the UK’s latest inflation cycle—from initial post-pandemic increases in imported goods prices, to Ukraine-related big rises in energy costs, to very high food price inflation, and eventually to elevated service price inflation—are clearly visible in Exhibit 2. By August 2024, the effect of global shocks on imported goods and food prices had broadly disappeared and the impact of energy prices was in fact to reduce inflation. What was left was the large contribution from mostly domestic services.
Upward price pressure in labour-intensive services is now abating, with wage growth slowing. However, another service component – housing rents – continues to increase. Of the 219 detailed categories of goods and services monitored by the Office for National Statistics (ONS), actual rents paid for housing are the single largest item, making up 8% of the entire consumer basket. And these costs posted a 7.2% annual increase in August 2024. Housing costs may well be the last wave of this inflation cycle.
Huge variations in inflation experienced by different households and businesses
Housing costs are also an excellent example of the uneven effects that the cost-of-living crisis has had on households. Each household spends their money on different things and are therefore exposed to different price rises.
For much of the period of high inflation, private renters’ costs were increasing considerably slower than those of mortgagors and other owner occupiers. In the year to October 2022, the ONS’s household cost index for mortgagors increased by 13.7%, while the corresponding increase for private renters was 10.2%1. More recently, however, private rental prices have been accelerating. Since December 2024, rent paid by new tenants has increased from 27% to 30% of gross earnings, and in June 2024, private renters’ household cost index, at 3.2%, was nearly as high as that for mortgagors, at 3.7%.
Similarly, two years ago, inflation was biting hardest for households in the lower income deciles while the position has now been reversed. In the year to June 2024, the household cost index for the 9th (near-highest) income decile went up by 3.3%, while costs of households in the 2nd (near-lowest) income decile increased by 1.7%. This reflects the fact that higher-income households are more likely to be exposed to mortgage interest rates, while lower-income households have benefited relatively more as electricity and gas prices have come down.
Things are even more complicated for businesses, many of whom not only serve several different customer segments, with different responses to high inflation, but have themselves experienced volatile and unpredictable costs and prices. For example, input costs for manufacturers increased by 24.4% in the year to June 2022, while producer prices in services grew by 5.4%. In the 2nd quarter of 2024 (the latest time period for which data is available), the situation had flipped, with manufacturing input inflation at -0.7% and services producer price inflation at 3.1%.
Practically no individual household or business has experienced the headline, aggregate CPI inflation that is generally reported in the media.
A premium on foresight capabilities combined with agility
As global and UK economic circumstances in the last few years changed rapidly, and unpredictably, we came across no businesses with a crystal ball able to accurately predict costs and prices. However, there were many organisations that successfully navigated the turbulence by deploying a combination of analytical insights, foresight capabilities, and agility. There are three practical lessons to be distilled for business leaders:
- Stay ahead by monitoring economic signals: Inflation may be stabilizing, but the underlying forces driving price fluctuations remain complex and unpredictable. At the same time, the data available to understand what’s going on has never been richer. The best businesses combine their own detailed data and analytics capability with a constant grounding of strategy in a solid understanding of the external context.
- Use scenario planning to prepare for multiple outcomes: In our experience, the point of forward-looking projections is not to guess the exact shape of the future. That is impossible. Instead, by exposing decision makers to a wide range of possible outcomes, companies can get decision makers ready to act—surgically, quickly, and decisively—as specific scenarios play out.
- Make sourcing and pricing adjustments a routine process: Many businesses were slow to respond to the challenges of high inflation. For example, in 2022, only 40% of UK firms revised their prices more than twice a year. Even then, price changes and supply chain reviews were often one-off initiatives. However, as business cycles come and go, the optimal approach is constantly changing. To stay competitive companies need to make sourcing and pricing reviews routine rather than reactive and build the agility to follow through on a continual basis.
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The outlook for UK inflation may be stabilising. However, as yet unknown global shocks could destabilise prices again, or other economic variables might move to undermine business plans. Building foresight capabilities and agility will help companies to be forewarned and forearmed and to respond effectively as circumstances change.
1. Unlike the Consumer Price Index (CPI), the ONS’s Household Cost Indices include mortgage interest payments, allowing a more meaningful comparison of cost pressures facing different types of households.
Sources:
Forecasts for the UK Economy: September 2024, HM Treasury, September 2024
Energy price cap (default tariff) update from 1 October 2024, Ofgem, August 2024
Commodity Markets, World Bank, September 2024
Average weekly earnings in Great Britain: June 2024, Office for National Statistics, June 2024
Renter affordability for new tenancies, Office for National Statistics, September 2024
Latest Results from the Decision Maker Panel Survey – 2023 Q2, Bank of England, June 2023