UK Reaction: Rising energy costs drive inflation to 11.1%

• Consumer Price Index (CPI) inflation rose to 11.1% year-on-year (y/y) in October up from 10.1% in September, as rising energy and food prices pushed inflation to a new 40 year high.

• This reading surprised to the upside, above consensus estimates of a rise to 10.7% and Bank of England (BoE) estimates of a 10.9% rise.

• Core inflation remained at 6.5% in October above consensus estimates of core inflation declining to 6.4%.

• Despite the government’s Energy Price Guarantee (EPG), gas and electricity prices which rose by 24% on the month made the largest upward contribution to the rise, contributing 0.8 percentage points (ppts) to the 1 ppt rise.

• We continue to expect the BoE’s Monetary Policy Committee (MPC) to hike Bank Rate by 50 basis points (bps) in their December meeting. The upside surprise in inflation and more importantly the fact that core has yet to begin decelerating will underscore for the MPC the need to lean against inflationary pressures. 

CPI inflation rose to 11.1% year-on-year (y/y) in October up from 10.1% in September, as increases in household energy and food prices pushed headline CPI to a new 40-year high. This reading came above consensus estimates of a rise to 10.7% and BoE estimates of a rise to 10.9%. Core CPI inflation remained at 6.5%, above consensus estimates of a fall in core CPI to 6.4%. Retail Price Index (RPI) inflation rose to 14.2% whilst RPI excluding mortgage interest payments (RPIX) rose to 13.9%.

Despite the EPG, gas and electricity prices made the largest upward contribution to the rise, contributing 0.8 ppts to the 1 ppt rise on the month. The EPG fixed the unit cost of electricity and gas capping the average prices paid by household, but this still constitutes a sizeable rise compared to the previous Ofgem cap. Overall the price of electricity, gas and other fuels rose by 24.3% between September and October 2022. The Office of National Statistics estimate that without the EPG, electricity, gas, and other fuel prices would have risen by nearly 75% on the month. Alongside energy, rises in food prices contributed to the upside surprise in inflation (+0.2 ppts), food prices rose 2% on the month with food inflation now standing at 16.4% y/y. Rises in the price of items for recreation and culture also contributed to the rise (0.1 ppts). Falls in transport prices offset the overall rise, (-0.2 ppts) driven by declines in the price of motor fuels and second-hand cars.

We expect inflation to gradually ease over the coming months, but with continued upward contributions expected from food will keep the headline level elevated around these levels until mid-2023. Policy choices to be set out in the Autumn Statement on Thursday will be key. In our outlook, the Chancellor’s plans for the current price cap to end in March and replaced with more targeted support could see inflation rise in April as we assume prices revert to the Ofgem price cap. Additional support could see a faster decline in prices than we currently expect. We increase our forecast for 2022 to 9.1% (from 9.0% prior) and continue to see inflation averaging 7.6% over 2023.

We continue to expect the MPC to hike Bank Rate by 50 bps in their December meeting. The upside surprise in inflation and more importantly the fact that core has yet to begin decelerating will underscore for the MPC the need to lean against inflationary pressures. We pencil in further hikes of 50 bps in February and 25 bps in March bringing Bank Rate to 4.25% but expect the BoE to begin unwinding some of these hikes towards the end of 2023, pencilling in one cut in Q4 2023 to 4.00%.

Markets reacted to the upside surprise in inflation with the pound falling back 0.4% against the dollar following the release of the data but has since retraced these losses. The pound also fell 0.3% against the euro.