GDP growth in Q1 this year was probably stronger than the MPC expected a few months ago, leaving GDP roughly 1% above the Q4-19 level, just before the pandemic. Unemployment has returned to the pre-pandemic level, just below 4%, and has not been lower since the mid-1970s.
Less welcome, inflation has risen sharply, with headline CPI inflation at 7.0% YoY on the latest (March) figures, and core at 5.7%. The QoQ annualised rates are running at around 7¼% for headline CPI and 6.5% for core.
The BoE staff forecast is that the upcoming April figures (published on 18 May), which will include the recent rise in the Ofgem price cap, will show headline CPI inflation at around 9% YoY. As last year, the ongoing inflation pickup partly reflects higher energy prices, including effects linked to Russia’s invasion of Ukraine.
The direct effect of energy prices on the CPI is already substantial and is likely to rise further during this year. Part of the inflation pickup reflects buoyant consumer goods prices, resulting from the global imbalance between strong demand for consumer goods and constrained supply.
But the rise in inflation has become more broad-based, and partly reflects domestic cost and capacity pressures, because the recovery in activity has exceeded the economy’s potential supply. Capacity use in firms is well above average.
The labour market is very tight – and has continued to tighten in recent months – with elevated readings for firms’ recruitment difficulties and a high level of vacancies.
It is not straightforward to disentangle the influence of these (and other) factors. One approach is through decompositions of CPI data, apportioning items as being driven more by external and domestic factors. For example, one might attribute the surge in non-energy consumer goods prices mainly to external factors. Conversely, the rise in core services inflation – which is relatively less affected by global factors – points to the role of domestic factors.
These distinctions between domestic and external factors are not definitive. Energy prices have some effect on services prices. And it is notable that non-energy consumer goods prices as a whole have risen much more sharply in the UK than the Euro Area over the last year, which may point to some role for domestic factors in goods price inflation.
The rise in inflation is already creating spillovers to the economy, including second-round effects on wages and costs. Longer-term inflation expectations measured from households or financial markets have risen further and are uncomfortably high.
There are signs that pay deals have picked up markedly this year. The BoE Agents report that the tight labour market is the main driver pushing up pay deals, but the high rate of actual and expected inflation is also a major factor. Business surveys suggest that firms expect to continue to raise their selling prices rapidly, and there is little sign that firms’ pricing strategies are constrained by the 2% inflation target. Uncertainty over inflation has risen, especially among firms affected by supply and labour shortages and in energy-intensive sectors.
