Inflation surged in 2022, but will it reverse in 2023?

It has been in the news a great deal recently, and its effects have been felt by everyone in one way or another. This has meant significantly higher prices for food, groceries, energy and services. This has had an impact on everybody’s household budget.

Inflation graph

Source: ONS, Eurostat, BLS.

After having reached a double-digit rate of increase in recent months, this now appears to have levelled off. So, has the rate of inflation now turned a corner? It’s fair to say that forecasters of inflation were way off target for 2022. For example:

  • In December 2021, the Bank of England’s Monetary Policy Committee said “CPI inflation was expected to remain around 5% through the majority of the winter period, and peak at around 6% in April 2022”.
  • Two months earlier, the Office for Budget Responsibility (OBR) in its Economic and Fiscal Outlook said “News since we closed our forecast would be consistent with inflation peaking at close to 5% next year. And it could hit the highest rate seen in the UK for three decades”.

The OBR was a decade out. At the time of writing, it looks as if the peak 2022 reading for UK CPI inflation was October’s 11.1% – the highest for 41 years according to the Office for National Statistics. Is that the peak for this inflationary cycle, as the data in the graph above hints?

Current forecast

The good news is that, as of now, inflation does look set to drop. Some of that is down to what economists call the ‘base effect’. Annual inflation is the difference between prices, 12 months apart, so each new month’s inflation calculation loses the oldest month of data which is replaced by the latest month. If the month that disappears was one in which there was an inflation spike and the new month is spike free, then inflation falls.

For example, if the rate of inflation in October 2022 was 11.1%, this means that prices are 11.1% higher than the same date a year prior. Something that would have cost you £100 in October 2021 would now cost you £111.10 in October 2022. If the same item in October 2023 then costs £114.43, this means that the rate of inflation for that item is 3% over the course of the year – the item costs 3% more than a year previously.

Review your plan

One point to remember is that a falling inflation rate does not mean overall prices are falling, so your financial planning may well need a review to take account of this. Even if the rate of inflation were to fall to zero, prices would still have risen. Falling prices is known as deflation, but that is not the same thing as the rate of inflation reducing.

Whilst the above is true, some commodity and service prices have in fact fallen from the highs created by Covid-19 supply issues and the Ukraine war, and these will feed through to domestic inflation. For example, by mid-December the price of wheat had almost halved from its February peak. Shipping costs have also fallen dramatically from their 2022 highs.

At the same time, surging inflation has justifiably caused employees to seek higher pay settlements with their employers. As wages rise, this tends to embed higher inflation as rising prices drive higher wages, and higher wages feed higher prices for goods and services.

Overall, it is highly probable that it will fall back from the current double-digit level, but it may not return to the previous (and more modest) 2% Bank of England target. This is could mean that the central bank may continue to raise interest rates further in 2023, which will have an impact on the economy as a whole.

There is clearly a lot happening economically. All of this highlights the importance of financial planning, which allows individuals to factor these effects into their lives with confidence, and to look ahead without worry, regardless of the economic situation.

If you would like to reach out to discuss your financial plan, please do get in touch.

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and the value of investments can fall as well as rise. No representation is made that the stated results will be replicated.

James Batchelor

James Batchelor

Chartered Financial Planner

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