The surge in energy prices has significantly lifted headline inflation rates in the UK and Eurozone through the direct impact on household energy bills. However, there is a lag to the feed through from rising energy costs and consumer inflation of several months. Energy prices fell in the last months of 2022 as European gas tanks were full to bursting, but the effects of the high prices in the second half of last year may still be felt in the first quarter of 2023, says Oxford Economics in a note.
The rise in energy prices has resulted in an increase in inflation rates, with a considerable impact on the cost of services and non-energy goods. This impact can be seen in the wide gap between the inflation rates of services and non-energy goods with high and low energy intensity, Oxford Economics said.
The effects of energy prices on inflation go beyond direct impacts, such as higher petrol, electricity, and gas prices. Indirect effects are significant, with restaurants being one example. Rising energy costs increase the costs of preparing food and the production of food, and this eventually leads to higher prices of food and drink sold by restaurants. The same can be said for other non-energy items in the Consumer Price Index (CPI). Although the impact varies across sectors, the indirect effects of energy prices on inflation are likely to be substantial.
The rise in energy costs for businesses has been even more significant than for households. Energy costs have risen more for businesses in percentage terms, partly due to the presence of costs in household bills that don't respond to wholesale fuel prices. Average gas prices paid by UK businesses rose by 170% between the fourth quarter of 2019 and the third quarter of 2022, far above the 80% rise for UK households. Similarly, household gas prices rose by nearly 40% in the fourth quarter of the last year, bringing the total increase to 150%, according to Oxford Economics.
“The impact of energy prices on inflation is likely to continue in early 2023 and may even increase further. This highlights the risk that core inflation and services inflation will be persistent in the near term. However, if wholesale energy prices follow the path indicated by futures markets, the indirect impact on inflation from energy should diminish over the next two to three years,” Oxford Economics said.
In conclusion, the indirect effects of energy prices on inflation make it challenging to use core inflation and services inflation as a reliable guide to underlying domestic inflation pressures. The energy crisis has created a complex and widespread impact on inflation, and its effects are likely to be felt for some time.
“This underscores the risk that core inflation and services inflation will be sticky in the near term. Subsequently, assuming wholesale energy prices follow the path implied by futures markets, the indirect impact on inflation from energy should fade over the next two-three years,” Oxford Economics said.