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Rising costs could lead to bumpy road ahead

By Conor Lambe, Chief Economist at Danske Bank

As the economic recovery from the impacts of the coronavirus pandemic in the UK continues, a parallel theme has emerged alongside the rise in activity – higher prices.

Over the last number of weeks we’ve heard more about, for example, the rising cost of energy, fuel, housing and building materials.

Looking at the latest data, we have seen higher rates of price rises for consumers, producers and in the housing market.

During the first quarter of this year, consumer price inflation was below 1%, but in the second quarter CPI inflation averaged around 2%, and while the headline rate declined from 2.5% in June to 2.0% in July, it is expected to rise again over the coming months.

In the August 2021 Monetary Policy Report, the Bank of England’s Monetary Policy Committee projected that inflation would rise to around 4% in the final quarter of this year. This would represent the highest inflation rate since the final quarter of 2011, if it materialises.

There are a number of factors that can help to explain this higher inflation.

One is increased fuel prices. In July, the annual inflation rates for petrol and diesel were 19.1% and 16.0% respectively. Linked to this, oil prices were over 70% higher than they were in July 2020 when the pandemic had led to lower levels of global economic activity.

Another is disruption to global supply chains having impacts on the supply and price of certain goods. The August 2021 CBI Industrial Trends Survey revealed that stock adequacy in the UK manufacturing sector fell to its weakest ever reading and the CBI Distributive Trades Survey also showed firms facing challenges in relation to stock levels in the retail and distribution sector. The disruption to supply chains is directly pushing up prices in some instances as demand exceeds supply, but it is also indirectly affecting prices. For example, the global shortage of semiconductors has adversely impacted new car production, which may have supported a rise in demand for used cars and contributed to the 14.4% price rise for them observed in July. 

The reopening of the consumer-focused parts of the economy has also likely played a role as demand and prices in some consumer goods and services sectors have increased. For example, household furniture prices were up by 6.9% over the year to July and the prices of hotels and accommodation services were 6.7% higher as people took ‘staycations’. 

These factors are also likely to contribute to higher rates of inflation over the coming months.

The latest producer price inflation data also shows price pressures further up the supply chain. Since April, the annual rate of input price inflation experienced by UK manufacturers has exceeded 9%. The last time it was at similar levels to this was in the early part of 2017. Output price inflation for UK producers selling domestically increased to 4.9% in July – the highest it has been since December 2011.

These higher rates of producer price increases also support the view that consumer price inflation is likely to rise over the coming months as some of these costs may be passed down the supply chain.

Another area were we have seen increases in prices has been in the housing market. House prices in the second quarter of 2021 were 10.9% higher across the UK than in the second quarter of last year. In Northern Ireland, they were 9.0% higher.

A number of different demand factors have contributed to this rise in house prices including savings built up by some households being used to help buy a property; people re-evaluating their housing needs and looking for bigger properties with, for example, more outdoor space; continued low interest rates and the Stamp Duty holiday. On the supply side, constraints in the supply of housing have also continued to exert upward pressure on prices. 

The price rises being observed across the economy have recently seen inflation come back into focus. As the economy hopefully continues its recovery over the coming months and into next year, what happens to prices will be an important factor to monitor for both businesses and policymakers.

This article was published in The Belfast Telegraph on 31 August 2021.

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