Inflation Outlook Post-Budget

The past week has been frenetic in UK inflation markets, as governments worldwide remain focused on containing inflation to avoid electoral repercussions. Ahead of the budget, there was speculation that Chancellor Reeves might remove the 5% VAT on domestic energy bills, which was expected to reduce inflation over the next year by 0.2% to 0.3%. This speculation caused 1-year inflation swap rates to decline accordingly.

In the days leading up to the budget, leaks suggested this VAT removal would not occur, and inflation swaps reversed. Indeed, the 5% VAT remains in place. However, less well-telegraphed is that the average household energy bill is expected to fall by around £150, from approximately £1,760 to £1,610 in April, due to the removal of the green energy levy and the transfer of renewable obligations to the general budget. This 8.5% reduction in energy bills is likely to have an even larger near-term disinflationary effect than the previously considered VAT removal.

This comes amid lower gas prices, potentially linked to a scaling back of the conflict in Ukraine, which further eases goods inflation. Services inflation, however, remains sticky and stubborn, meaning the overall inflation outlook remains subject to considerable uncertainty.

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Mark Greenwood

Deputy Chief Investment Officer

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