GLOBAL ECONOMIC TRENDS that have been the principal driver of the inflation surge of the past 12 months – including high demand for goods from US consumers and trade disruption, as well as fast rising energy prices – have all started to ease in recent months and will put downward pressure on inflation over the next 12-18 months, according to new Resolution Foundation research. 

The Foundation’s latest Macro Policy Outlook examines how global issues have fuelled domestic UK inflation, the impact of UK-specific issues such as Brexit, and how changes in all of these trends could affect UK inflation over the next 12-18 months.

The report notes with around three-quarters of the rise in inflation since April 2021 in the UK coming from import-intensive sectors – energy, food and other goods – global trends are having a huge impact on driving up UK domestic inflation, which last month hit a 41-year high of 11.1 per cent.

The report identifies three distinct, but related, global trends that have affected UK inflation:

  • First, demand for goods in the US has surged in the wake of the pandemic. Overall demand for goods in the US was up 6.4 per cent on its pre-pandemic path earlier this year, with consumption of recreational goods and vehicles, such as sporting equipment, up 21.2 per cent. This surge in demand, which has not been replicated in Europe, has nonetheless pushed up the price of globally traded goods. However, with demand now falling back – imports of goods to the US have now fallen 5.2 per cent from their peak in March – prices for goods are likely to fall.
  • Second, supply bottlenecks (driven in part by consumer demand in the US and manufacturing delays in China) have both disrupted and pushed up the price of trade. The cost of shipping (using the Baltic Dry Index) increased sevenfold last year in the wake of the pandemic. However, with the cost of shipping recently falling back to below double pre-pandemic levels, global trade costs have now become a deflationary tailwind.
  • Third, soaring global energy prices have had the biggest single impact on inflation – directly accounting for a third of inflation in the UK today. But while prices remain elevated compared to pre-pandemic levels, and future prices are highly uncertain, the price premium on European gas relative to US and Japanese gas has fallen back in recent months as the continent has transitioned away from Russian gas, with increased LNG imports and greater industrial energy efficiency.

The report notes that the UK’s exit from the EU has also created its own specific inflationary pressures – notably on food prices, which have risen by six per cent in 2020-21 due to new UK-EU trade barriers, and the value of sterling, which has fallen by four per cent against the basket of trade-weighted currencies. But the report notes that while these two issues are likely to leave prices permanently higher – making consumers permanently poorer as a result – their impact on inflation has mostly already passed through.

The Foundation concludes these global deflation tailwinds should contribute to inflation falling relatively fast over the course of 2023 and 2024, allowing the Bank of England to focus on inflationary pressures in the domestic economy, which is where monetary policy will bite.

However, it warns that with inflation likely to remain at double-digit levels until Spring 2023, real wages set to continue falling until early 2024, and the price of many goods likely to be permanently higher, these welcome economic trends will be of cold comfort to families who are already struggling to get by during an acute cost-of-living crisis.

Emily Fry, Economist at the Resolution Foundation, said: “Double-digit inflation has caused an acute cost-of-living crisis, and prompted monetary policy makers to raise interest rates rapidly in response. But with so much of our inflation being driven by global factors such as trade disruption and energy prices, there are limits to how much domestic policy makers can do to tame price pressures.

“The good news is that many of the global factors that have caused inflation to soar are now unwinding and could cause inflation to plummet over the next 18 months. That may make central banks’ jobs easier, but it’s of little comfort to families still grappling with shrinking pay packets and high energy bills.”

* Read: Macroeconomic Policy Outlook: Q4 2022 here.

* Source: Resolution Foundation