UK Inflation Set to Break 2% Target Again: What Investors Should Know
- John Choong
- Nov 19, 2024
- 4 min read
Inflation is set to have risen to 2.2% in October. Core inflation may see a slight drop to 3.2%, while services inflation rebounds to 5.0%.
Inflation Inflates Again
It seems like inflation is in a never-ending cycle. Having receded all the way back to 1.7% from its peak of 11.1% exactly 2 years ago, headline inflation is expected to climb back up again this winter — and it begins with next week's October print. Unfortunately, according to the Bank of England's (BoE) latest estimates, the inflation rate isn't forecast to drop below the BoE's 2% target until the spring of 2027, as core and services components remain elevated.
So, why is the Consumer Price Inflation (CPI) set to rise again? It's all mainly thanks to a combination of higher energy prices and rebounding food inflation. It's worth noting that both food and energy have an impact on over a third of the inflation basket, thereby showing how susceptible the UK's inflation rate is to these two elements.
In fact, one of the main reasons behind the decrease in inflation since 2022 was due to the massive fall in the Energy Price Cap (EPC). As such, this quarter's EPC jump from higher gas prices is set to reverse that tailwind. What's more, the many calls investment banks had made about food prices going down have failed to materialise, as grocery prices have now inflated higher for 2 consecutive month — the first time since March 2023.
Our Forecast
Our prediction is for headline inflation to rebound to 2.2% from 1.7% on a year-on-year (Y/Y) basis, in line with consensus estimates. But on a month-on-month (M/M) basis, we're forecasting headline CPI to rise by 0.5%, a tinge higher than official estimates of 0.4%.
So, what's behind our projections? As mentioned earlier, energy and food will be the main culprits behind the jump. We see the former (Housing & Household Services) jumping by an eye-watering 3.6% on a M/M CPI basis, while the latter (Food & Non-Alcoholic Beverages) rises by 0.7%.
Tip: CPI and CPIH rates have different weights in their respective inflation baskets, which can result in different inflation rates. Our forecasts only consider CPI, not CPIH. CPIH includes owner occupiers' housing costs.
Meanwhile, we expect hotel prices and airfares to resume their positive contributions to the inflation basket. This should result in services inflation ticking back up to the 5% mark, with Restaurants & Hotels seeing its M/M CPI rate increase by 0.3%. Nonetheless, while higher airfares should push the M/M inflation rate up for the Transport category, we're projecting a M/M decline of 0.3%, as lower petrol and diesel prices offset higher airfares.
On the other hand, we're estimating Furniture & Household Goods to deflate as they normally do in October, as end-of-season sales bring prices down, not helped by lower consumer sentiment (especially for large purchases). Though, this is likely be offset by strong M/M inflation from Clothing & Footwear, as the traditional October bounce should come to fruition. That said, on a Y/Y basis, clothing inflation should moderate, to 0.7% from 0.8%.
What Next for Investors
Where does this leave investors then? Well, ultimately, inflation is still on its way down, as the stickier core and services elements are still estimated to make a gradual decline over time. This, should lighten the load of many firms' costs base, while also seeing continued revival in revenue growth, as consumers and businesses have a bigger propensity to spend more — especially while real wage growth continues to trend above inflation.
Thus, for those with a higher risk appetite, both UK and US stocks remain attractive in our view. We see downside potential from lower energy prices over the medium term from easing geopolitical tensions — something we're hopeful from a Trump presidency. Paired with looming US tax cuts, and this should serve to benefit earnings potential for both US and FTSE 100 companies (which get about a quarter of their earnings from the US).
Tip: Stocks usually trade based on the potential of future earnings. If speculated earnings rise, so should share prices, because investors are happy to pay more for higher earnings in the future.
But for more risk-averse investors, fixed income options such as savings accounts or government bonds (gilts) yielding 4%+ may be a better option for now. The 5Y gilt currently pays a decent 4.33% per year. With gilts having seen a sell-off after the recent Budget, another onslaught is unlikely. This should give investors some margin of safety, while also being able to hedge with a healthy yield that's expected to be double the inflation rate.
Tip: A gilt's yield serves as a hedge. If the price of a gilt drops, investors will still receive a return if they hold onto the gilt until maturity. Vice versa, they can also sell a gilt if it's gone up in price and repurpose the cash elsewhere.
*These forecasts represent opinions and analyses based on available data at of the time of publishing, which may prove incorrect. This content is for informational purposes only — please consult a qualified financial advisor for personalised investment advice.
