The Inflation MistakeWhy inflation in the UK will have a second wave.

Inflation was one of the fundamental stories across the investing world and has decreased substantially from its peak in 2022. Politicians have been patting themselves on the back, especially in the United Kingdom, with Rishi Sunak quick to take credit for this decline.

The working assumption has now moved to a reduction in interest rates in 2024 with cuts being priced in as early as May.

Celebrations!!!! Maybe not just yet!

While this may come to fruition, there are a few reasons why this is probably wrong – at least when it comes to the UK and the Bank of England.

1. Owner Occupied Housing Costs on the Rise 

One important component of the inflation picture is Owner Occupied Housing Costs (OOH), which is approximately 16% of total inflation.

These include:

  • Council tax
  • Electricity, gas and other fuels
  • Water and sewage
  • Council tax
  • Rents
  • Owner Occupied Housing Costs – i.e. mortgage costs

This element of inflation has been growing faster than the overall picture and still increasing, despite wider measures of inflation declining.

    All of the elements of OOC are increasing except for a historic drop in electric and fuel costs, which remained elevated since Russia’s incursion into Ukraine. This isn’t even due to government intervention. Record oil production in the USA, international sanctions (and easing of sanctions, in some instances), and the way the calculation is done all conspired to reduce energy’s contribution to inflation.

    A key consideration though is that the impact of the interest rate increases hasn’t even filtered through to the data yet. 

    The Office for National Statistics expects that 1.4 million households will have their mortgages renewed in 2023 from pre-2021 levels when interest rates were <2% on average. Renewal interest rates averaged between 5% – 6%, meaning that those mortgage payments have roughly doubled.

    This has already occurred! It just hasn’t shown up in the data yet. 

    Given that OOC is 16% of CPI, we can expect CPI in the next 12 months to be elevated, unless the impact of this increase can be offset by declines in other areas. 


    2. Impact of Geopolitical Stress on Supply Chains

    It is undeniable that we are living in a world of greater geopolitical conflict than the previous 20 years. We currently have 3 primary theatres of conflict.
    1. Economic conflict between the world’s preeminent economies – the USA and China
    2. Actual and threatened military conflicts within and around oil production centres – such as Israel – Hamas, Russia-Ukraine and the Guyana-Venezuela region, to name a few.
    3. Political instability within commodity centres – particularly in Central and Eastern Africa.

    These epicentres of instability are likely to create friction between supply chains. Frictions create short term costs, as companies scramble to change their established routes for deliveries. One great example of this is currently playing out as we speak in the Red Sea.

    Impact of the Houthi Attacks on Shipping Lanes


    Commercial Trade Reroutes

    The Houthis in Yemen have been increasing their attacks on ships in the opening of the Suez Canal and Red Sea, allegedly in retaliation for Israel’s military operation in the Gaza strip. This adjustment will add about 10 days to travel for shipping routes from Asia and the Middle East through to Europe.

    This additional disruption will inevitably add costs to these goods, particularly in Europe, which is a key destination for much of this trade. 

    The fact that this disruption is occurring at the same time that another crucial maritime shipping lane, the Panama Canal, is being obstructed by a historic drought, exacerbates the impact of this issue.

    A more pertinent concern is if the risk of conflict begins to become entrenched in decisions by political and corporate decision-makers. The longer disruptions like these damage supply chains, the more likely decision-makers are going to emphasise the resiliency of supply chains rather than their efficiency.  

    Resilience comes with costs and both of these will likely filter through to the costs of goods. 

    The Bottom Line


    The inflation picture for the UK then is challenging. The main source of the drop in the inflation rate has been factors that are both outside of the UK’s control AND on thin ice at the moment. When the increase in OOC gets included in the calculation and supply chain disruptions feed through to goods and energy prices, it is unlikely that inflation will remain dampened.

    Furthermore, both the UK’s fiscal position and political positioning mean that there is unlikely to be any relief on the policy front. This means that the central bank will have to do all of the heavy lifting, which will be bad news for anyone betting on a relief on interest rates any time soon.