Analysis: How far and fast will inflation rise?

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One of the big headwinds facing consumer spending is the pick-up in consumer price inflation set to occur over the next couple of years.

However, it shouldn’t be too much of a squeeze on real spending power and there are some other offsetting factors which should support spending.

Of course, inflation always looked set to rise as the drag from lower fuel, food and other energy prices faded.

But the sharp drop in the value of the pound since the EU referendum will drive inflation up further and faster than previously expected.

In retail, this month’s “Marmitegate” episode has drawn attention to this in particular.

“Consumers are likely to see inflation close the gap entirely over the next few years as real wages remaining stagnant”

The exchange rate has now fallen by over 16% on a trade-weighted basis since June 23. This will have both direct and indirect impacts on the level of consumer prices.

First, it will directly boost the price of imported goods and services. But it will also raise UK manufacturers’ input costs, which can then feed through into higher finished goods prices.

Competitive environment

Admittedly, the tough competitive environment between firms and on the high street means that producers, wholesalers and retailers choose to absorb some of the increase in costs rather than pass the increase in full on to consumers.

Nonetheless, even accounting for this, inflation still looks set to rise considerably. We think that it will breach the Bank of England’s 2% target early next year, and is likely to rise above 3% in 2018.

This means that after a few years of positive real wage growth, consumers are likely to see inflation close the gap entirely over the next few years as real wages remaining stagnant.

This will clearly act as a significant headwind to spending.

That said, with interest rates likely to remain at rock-bottom levels, the Chancellor is likely to step off the austerity accelerator pedal for the Autumn Statement.

And with consumer sentiment still strong, we don’t expect the slowdown in consumer spending to be particularly severe over the coming years.