City braces for inflation rebound
Inflation will bounce back in January, figures out later this week will show, fuelled by rebounding airfares and the impact of VAT on private school fees.
City analysts expect the headline rate of inflation to rise to 2.8 per cent, up from 2.5 per cent in December.
The increase will largely be driven by price increases in the services sector, which rate-setters have identified as a crucial metric of inflationary pressures in the domestic economy.
Services inflation is projected to jump back up to 5.2 per cent, having dropped to 4.4 per cent in December on the back of unusually weak airfares.
“We expect a massive rebound in airfares inflation and a jump in private school fees to boost services inflation to 5.2 per cent in January, from 4.4 per cent in December,” Rob Wood, chief UK economist at Pantheon Macroeconomics said.
Private schools had to start paying 20 per cent VAT from January. Economists think around two-thirds of this will be passed on in the form of higher school fees.
Sanjay Raja, chief UK economist at Deutsche Bank, said the risks were skewed to the upside given the “very volatile” shift in services prices in December.
Business surveys also suggest that firms are planning to pass on higher costs to consumers ahead of April’s national insurance hike.
The latest purchasing managers’ index for the services sector showed that prices were climbing at the fastest pace in over a year.
“We assume that services companies already begin to pass through part of the increase in costs expected from the employer national insurance hike due to take effect in April,” analysts at Goldman Sachs said.
Looking later into the year, economists expect inflation to continue rising, largely due to the impact of higher energy prices and regulated prices – such as water bills and bus fares.
The Bank of England’s latest forecasts suggest the headline rate of inflation will peak at 3.7 per cent in the third quarter, although services inflation will gradually get weaker as the year progresses.
“Inflationary pressures are building,” Raja said. “Higher energy prices, first and foremost, have raised our projections meaningfully over the year.”
However, the Bank is still expected to cut rates three times this year, because the surge in inflation is not expected to generate significant second-round effects.
Second-round effects capture the knock-on impacts of higher input costs, such as firms raising prices to maintain their margins, and workers demanding a pay rise as things get more expensive.
“In central bank parlance, that suggests that the BoE will see through (higher inflation),” Vasileios Gkionakis, senior economist at Aviva Investors, said.