Inflation in Decline? A Look Behind the Scenes

This week, news may circulate suggesting a rosier short-term economic outlook. The report due on Wednesday could show a decline in overall inflation from 2.2% to 1.9%, which is below the target of 2% - a reduction achieved for the first time since April 2021. Could the inflation problem be truly resolved? Not quite. The decrease is mainly due to recently falling gasoline prices, which dropped by 4% compared to the previous month. This component alone could subtract 0.4% from the annual inflation rate. However, the core inflation rate, which excludes volatile elements like food and energy, might only marginally drop from 3.6% to 3.5%. The persistently high rate of price increases in the services sector presents another challenge. Although a decline from 5.6% to 5.2% is expected, this figure remains alarmingly high. One of the main reasons is the rise in average earnings by about 5% per year. Additionally concerning are the anticipated challenges due to the recent generous wage increases, such as for train conductors and junior doctors. These could, coupled with upcoming minimum wage increases, exert pressure on unit labor costs. There are also tensions on the demand side. The government is relying on increased investment as a growth strategy. The financial leeway needed for this is expected to be achieved through increased borrowing. However, this could unleash additional inflationary dynamics, which in turn will influence the Bank of England's monetary policy. Markets have already adjusted their expectations regarding future interest rate cuts. The 10-year government bond yield stands at 4.2%, a reaction to both global trends and national developments. The challenge for the new finance minister is to maintain trust while attempting to preserve economic balance.