By Catherine McBride – 4 minute read
THERE ARE some interesting things in the latest inflation numbers. The CPI for goods fell from 10% to 9.7% but the CPI for services increased from 6.9% to 7.4%. The CIPH all service index rose to 6.3% in the 12 months to May 2023 – the highest rate since July 1992.
Some people might be worried about this, and the ONS adds several caveats about the increase in services due to the dates of Easter and the type of live music events being held in the UK, but I see this as a Brexit benefit. The biggest component of any services is wages. So what we are seeing in today’s inflation numbers are the result of higher wages.
For a long time, almost 20 years, free movement of people from the EU, removed the need for many UK service providers to increase wages. If their staff complained, they could be replaced with someone from Poland or Lithuania, and from 2007 with someone from Bulgaria and Romania and from 2013 with someone from Croatia. These former communist countries had the lowest wages in the EU at the time, so their young workers were happy to move to the UK to work in coffee shops and restaurants or as construction labourers and fruit pickers and earn UK wages.
While this was very good for the labourers as their UK wages after taxes and cost of living adjustment were still up to two and a half times higher than in their home countries, and good for UK employers who were able to lower their wage costs, and also good for UK consumers who benefited from not only cheaper services but a mushrooming of services from home deliveries, au pairs, nannies, handymen, plumbers, and coffee shops – now on every corner.
But the downside was that many itinerant workers from the former Eastern-bloc countries were happy to live in dormitory houses or caravans while they sent as much money as they could back to their relatives at home, so most of their wages were not being spent in the UK and benefiting the UK economy. This also put a lid on the wages of UK workers in the same industries who now had to compete with HGV drivers who were happy to live in their trucks, and construction workers happy to share houses with up to 30 occupants sleeping in bunk beds and fruit pickers happy to share a caravan at the farm and work up to 80 hours a week.
Now that we have left the EU many of these workers have gone home, as wages have increased in most eastern EU countries – or taken up UK settled status and now live like everyone else in houses, with cars, children, pets etc. The UK’s golden period of a cheap service economy appears to be over. Now UK workers can strike for higher wages without fear of being replaced by someone who will work for less, and workers from train drivers to hospital staff have been doing so. The growth in average regular pay was 7.2% in February to April 2023. The largest growth rate outside the pandemic period. (Apr-Jun 2021).
While today’s inflation numbers have upset the commentators who expected today’s inflation number to fall, the increase in wages for UK residents who will spend their money here, will eventually be good for the economy. Goods inflation is falling and so although real wages are still negative, they are heading in the right direction.
The biggest contributing sector to both CPI and CPIH was Recreational and Culture and this will be in part due to higher wages. The good news is the largest increases in this sector were air travel and admission fees to live music events, both are generally discretionary spending so can be avoided.
But there are other costs in services besides labour. Any trades person working in central London has the added costs of ULEZ payments, Congestion Zone payments, parking payments, and probably the extra time taken to navigate through Low Traffic Neighbourhoods, road works and even stop-oil protesters, all while burning extra fuel with fuel duty of 52p per litre. These costs are passed on to the customer with the addition of 20% VAT. They aren’t new costs so not in the CPI monthly increase, but they still add to total bills unnecessarily.
An index of the amounts added to UK goods and services by various levels of government for rates, charges, duties, VAT and other regulations would show another cause of consumer price increases.
Many commentators on social media are rushing to demand that the Bank of England raise rates again, certainly the money markets seem to be expecting this. A spokesperson from JPMorgan thinks the UK needs a big rise, not just 0.25%. But I am not so sure that I would rush to this conclusion.
Eventually the home office will process the applications of the thousands of asylum seekers and refugees living in hotels in the UK and they will no doubt be able to work here. As will the thousands of students who are now able to work here for two years after they graduate. And if the EU remains in recession people who once found work in Germany or France will also be heading to the UK, by fair means or foul. Thus, the price of labour will start to fall and consequently so will CPI services and to a lesser extent goods. Interest rates are already going to reduce demand as people’s fixed rate mortgages expire, increasing rates again won’t hurry this and won’t hurt people whose mortgages are still fixed or already paid off. Both groups are surprisingly large. It will hurt businesses who generally borrow at variable rates.
Driving the economy is like driving an oil tanker, they are both slow to react to changes of direction. This is also why the MPC should have started increasing rates in 2021 not 2022, but having missed that boat it is too late to panic now. Additionally, the pound is higher against many of our import suppling nations so I would expect the price of imported food and consumer goods to continue to fall without further UK interest rate intervention.
As for the people comparing UK inflation to countries that are already in recession – they seem to be missing the point: nothing dampens demand like a recession. Of course their inflation is lower. And anyone comparing UK inflation to countries that are exploiting their own oil and gas reserves… well, don’t get me started.
Finally, the idea that the government should compensate people whose mortgages have gone up is entirely counterproductive to having an independent Central Bank in the first place. What is the point of pretending that the Bank can control inflation if the government keeps subsidising people to compensate for the effect of the Banks actions? Who even thought this was a good idea? The reason we have an independent central bank is so they are not swayed by attempts to be popular with voters.
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Catherine McBride is an economist and the author of Brexit and UK trade – What has changed? a paper analysing UK trade performance by sector since Brexit. She is a member of the Government’s Trade and Agriculture Commission.