Posted on: 16 September 2016
In this week’s The Commentary we take a closer look at inflation post-Brexit and in particular what this may mean for spending in the higher wealth brackets.
Strong headline figures
Throughout the summer many commentators and national newspapers have been analysing UK inflation figures and interest rates scrupulously to work out what effects Brexit has had on consumer confidence and Britain’s position as a leading economy.
Of course British holiday-makers who made it off our island this summer, will have felt the effects first hand of Britain’s decision to leave the EU, as the weak pound – down by one-tenth – made foreign goods pricier.
This week The Office for National Statistics (ONS) published its Consumer Price Index (CPI) for August, indicating year-on-year inflation remained unchanged for the month at 0.6%.
Mike Prestwood, ONS’s head of inflation, explained that “fuel costs falling more slowly than a year ago as well as rising food prices and air fares all pushed up CPI in August, but these were offset by hotels, wine and clothing leaving the headline rate of inflation unchanged.”
In addition the ONS also released this week its Retail Prices Index (RPI) – a separate measure of inflation, which includes housing costs – fell to 1.8% in August, down from 1.9% in July.
Against a backdrop of no significant rise in inflation, August’s manufacturing Purchasing Managers’ Index (PMI) UK survey showed a bounce back in activity from 48.3 recorded in July to 53.3 recorded for August. A reading above 50 suggests the manufacturing sector is expanding, with a reading below 50 indicating contraction. August’s reading shows that the immediate fears post the referendum result about an immediate slowdown in the UK economy appear to have been overblown. Over the medium term however, we may well see a deceleration in economic growth.
The story behind the headlines
By all accounts this week’s CPI inflation data seems to suggest there is little for the British consumer to worry about. However, there is reason to believe that the eventual “pass-through” of a weaker pound to consumers could be significant.
The Producer Prices Index (PPI) was also published by the ONS this week and it showed sterling’s slump has already impacted the cost of imported goods. Material prices climbed 9.3% (1) in the year to August. Reacting to this, companies can either opt to absorb these rising costs or pass them on to consumers - which forces up prices and the rate of inflation.
The usual thinking goes that a 10% fall in sterling eventually translates into a 2% rise in the consumer price index. Yet evidence suggests that Britain’s exchange-rate pass-through is larger than before. In the 1980s Britain’s bill for imports was worth 25% of GDP. It is now worth 31%. As imports make up a greater proportion of overall sales, inflation is more affected by exchange-rate movements(2).
Sterling’s weakness may well therefore lead to a rise in the price of imported goods, food, inputs and commodities. It is interesting to note that Apple earlier this month raised the price on some of its products in the UK on the same day as it unveiled the latest iPhone. This move has been blamed by some analysts on the sharp drop in sterling, following Britain’s vote to leave the EU.
In this context consumer purchasing power could become significantly diluted over the coming months as inflation trends higher and wage growth is limited. With average incomes increasing at just over 2%, it does not take much inflation to put real income growth firmly into negative territory.
Inflation measured by the CPI is focused predominantly on mass everyday spending. But the CPI may not be a completely true reflection on the way that the wealthier spend their money, for example on the cost of education.
This cost has sky rocketed and the Good Schools Guide 2016, released in May, acknowledged that in London average private school fees have risen at triple the rate of inflation over the past five years(3).
Furthermore, data from the Independent Schools Council's annual census (4) reveals an even starker picture of private school fees rising faster than the cost of living. Over the course of 25 years average private school-fees have risen 553 per cent and boarding fees are up 464 per cent. But consumer prices in that time have risen only 201 per cent and average wages are up 217 per cent.
The recent fall in the value of the pound is causing import prices to rise. If productivity growth does not improve then firms may be inclined to pass on these extra costs to customers through higher prices.
The next few months will be interesting to watch with regards sterling’s exchange rate value and the decisions companies will take to mitigate against higher import costs. We will be monitoring how this impacts inflation in our ‘inflation watch’ graphic in The Commentary and will assess how this is going to influence market sentiment over time.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.