The resurgence of inflation has been one of the key themes this year, and is the primary driver of the squeeze on households’ real incomes that is currently underway.
However, there are some good reasons to think that high inflation is not here to stay.
For starters, the almost 3% rise in consumer prices over the past year has been largely driven by the impact of the drop in the exchange rate that followed the vote for Brexit.
That depreciation in the pound made it more expensive to import raw materials and finished goods from overseas.
Admittedly, some firms decided to absorb some of that impact, allowing their margins to be squeezed, and limiting the final impact on the consumer.
Nonetheless, many firms were confident enough to pass on the increase in their costs, meaning that well over half of the increase in consumer prices can be attributed to this drop in the pound.
In the past, it has taken a number of years for this impact to fully work its way through the system. However, this time around, the drop in the pound appears to have had a more immediate impact.
“The rise in inflation has been a bit sharper than most anticipated. But thankfully, that means it should fall back reasonably quickly too”
As a result, the rise in inflation has been a bit sharper than most anticipated. But thankfully, that means it should fall back reasonably quickly too.
And there are already signs that this is happening, with firms’ input price pressures waning, and the inflation rate of imported goods having faded.
The factors which kept inflation high back around 2011 – notably a series of VAT hikes and commodity price shocks – seem unlikely to be repeated now.
So I think inflation is probably not that far away from peaking. It may inch above 3% briefly in the next few months, but it should start to drop back around the turn of the year.
Admittedly, inflation is likely to remain above the Bank of England’s 2% target throughout next year. But if I’m right in thinking that pay growth will see a modest acceleration, then real wages are likely to start rising again around the middle of next year.
So while this winter might be tough for the consumer, the prospects for next year look brighter.
Paul Hollingsworth is UK economist at Capital Economics