Tinkering with regulated prices won’t solve the cost of living crisis

Responding to the latest inflation data

The renewed decline in inflation in January, from 3.4% to 3.0%, is welcome but this rate is still a full percentage point higher than the official target of 2.0%. That target has not been met since June 2024, which happened to be the last month under the previous government.

The UK also remains an outlier, so this cannot be blamed on “global headwinds”. In particular, inflation in the euro area has been stable at around 2.0% and is expected to fall to just 1.7% in January.

The fall in UK inflation in January was helped by cheaper petrol, airfares, and food. The latter partly reflects declines in agricultural commodity prices worldwide. Inflation in the education sector also slowed, as the extension of VAT to school fees in 2024 dropped out of the annual comparison.

But otherwise, there was little change, with the core rate (excluding food & energy) slowing only marginally from 3.2% to 3.1%.

Inflation should drop more sharply in April, perhaps all the way to 2%. This would reflect the expected drop in domestic energy bills and smaller rises in other regulated prices, notably water bills and vehicle duties. In the meantime, the freeze on rail fares should lower inflation in March.

Nonetheless, tinkering with regulated prices is not a proper strategy to deal with the cost of living crisis. The government is simply transferring costs from household bills to general taxation, leaving many families no better off, while preventing markets from working as well as they should.

Photo by Christopher Bill on Unsplash

There is also danger that inflation does not fall as far as expected, or that it does not remain lower for long. Business surveys suggest that underlying cost pressures remain sticky, and medium-term inflation expectations are still too high for comfort. This is partly a result of government policy choices which have made labour and energy more expensive and increased the burdens of tax and regulation.

Last but not least, growth in broad money is running at annual rates of around 5%, which is also at the upper end of the comfortable range. This could mean that inflation just pops up somewhere else in the economy where prices are not being capped.

The government should refocus on getting the supply side of the economy right, freeing up markets to provide goods and services at lower prices across the board. In turn, this should ensure that more of the growth of the money supply is reflected in an increase in economic activity rather than higher inflation.