Inflation may be temporarily helping exporters, but rail users will feel more pressure from January

Tomorrow the Office for National Statistics will release the latest data on perhaps one of this year’s most-watched indicators: inflation. As we’ve been saying for nearly a year, inflation is likely the single most important economic story of 2017. The sharp deterioration in Sterling after the UK’s decision to leave the European Union last June set off a chain of events that have led to a sharp rise in inflation since then. This is because items purchased in other currencies (i.e. those which we import) are now more expensive, as every UK holiday maker knows with any holiday spending overseas costing more now than before the referendum.
A weak currency has long been championed as a way for a country to improve the competitiveness of their produce abroad, and we have seen signs of that over the past year. UK exports have increased since June 2016 as companies here see the costs of their goods fall to overseas buyers, allowing them either to increase their margins or offer more competitive pricing against other producers from different countries. However, because the UK imports so much (more than we export, so we run a trade deficit), those imports are affected in the opposite way: in Sterling, they’re now more expensive than they were before the devaluation. So, in short, everything we import costs us more and, because we import more than we export, this means that the long-run effect of the weakening of Sterling is negative overall for the country.

This pushes back against most popular commentary, that a devaluation is good for a country. I can be, particularly if you run a trade surplus, but, on aggregate, the UK will be worse off overall, even though some of our exporters will benefit from this. However, not all exporters will see a positive side: the nature of the UK economy, as an importer-exporter, applies to lots of companies, too. They often import lots of raw materials to make their own goods, so the benefit of a weak Sterling (decreasing their prices to overseas customers) also has that flip-side: the raw materials they buy increase in cost. Add to that commodities such as oil and fuel which, even when bought in Sterling, are priced internationally in Dollars, the input prices can rise significantly, eradicating much of the benefit of the depreciation.

The rise in input prices seems to have now peaked, and in the latest data is 9.9%. This is still high, but softer than the 20% peak we saw in January. However, for consumers, the pass-through of those input prices into the wider economy will take longer. Conventional wisdom is that it can take two years or more to fully embed itself in consumer prices, which is why we expect inflation to peak in early 2018 before slowly falling back. Last month’s data (for June) showed an unexpected fall, mostly caused by erratics such as oil, and we expect a further rise in the CPI level tomorrow. Our own research through the Quarterly Economic Survey suggests companies are still feeling the pressure of price inflation through exchange rates, and this is likely to continue into 2018 before the pressures finally ease.

But tomorrow’s rate is important for another reason. The July RPI data is used to determine the increase in rail fares next January. The latest data stands at 3.5% and tomorrow will likely see this number increase. With inflation now increasing faster than wages, there is increasing pressure on the spending power of individuals and households which may lead to a slow-down in the economy overall. A sharp rise in rail fares next year will place further pressure on people at a time when their pay packets are already shrinking in real terms. Brexit may not have happened yet, but its first effects are already being felt.

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