Much of UK inflation is (still) “imported”

With UK inflation hitting record high levels in December 2021, concerns are rising that it might not be as temporary as many previously thought. Inflation might become endemic — and potentially problematic — especially if price rises lead to (demand for, and actual) wage rises which in turn feed back into price rises (because companies’ costs have gone up and because, in a high-inflation environment, people are more likely to want to spend than save).

I have to admit that I have personally been somewhat surprised (relative to my views a year ago) by the supply-side tightness of the economy, as revealed in supply chain and labour shortages. I’m less convinced, as yet, that consumers are going on a (lasting) spending spree. [I’ve had a quick look at the Google mobility data — a decent predictor of consumer confidence — and it looks pretty downbeat for December and January.]

This distinction between supply and demand is, of course, important for making monetary policy decisions. Another useful way to understand the “shape” of inflation we are experiencing is to look at how much of it is “imported” — i.e., how much is attributable to goods and services for which prices are determined internationally (through the “law of one price”).

In the case of the UK’s recent experience, the answer is “a lot”. In the last quarter of 2021, only around 0.8%-points of the nearly 4.9% consumer price inflation came from the least-imported goods and services (the lowest segment in the right hand side column of the chart). In fact, compared to previous episodes of heightened inflation in 2008 and 2011 (the other columns in the chart), slightly more of the current inflation is from import-intensive good and services.

Of course, that doesn’t necessarily make the inflation either benign or temporary — but it does mean that decision makers will need to watch carefully not just UK indicators but global indicators of price dynamics. [I’m sure they are doing just that!]