Gas Market Turmoil Threatens to Halt Slide in UK Inflation

Renewed pressure in the UK’s energy market risks derailing Bank of England Governor Andrew Bailey’s effort to rein in inflation.

(Bloomberg) — Renewed pressure in the UK’s energy market risks derailing Bank of England Governor Andrew Bailey’s effort to rein in inflation.

The huge decline in natural gas and electricity prices this year has helped the UK cut inflation to 7.9% in June from a 41-year high of late last year. The Bank of England indicated earlier this month that the rate of inflation could fall by more than half this year, and toward its 2% target by 2024. But rising natural gas and electricity prices would slow down that trajectory. 

The energy price cap level, set by regulator Ofgem, is expected to ease slightly from October but to rise again in January, according to estimates from Cornwall Insights. 

Future gas contracts show wholesale prices rising more than 40% in January and again the following winter compared to today’s levels. Energy costs were flagged by BOE Chief Economist Huw Pill as a key factor that could derail interest rates with Capital Economics pointing to the recent surge in wholesale gas prices as something making the BOE’s task “harder.”

“In an environment in which firms feel able to pass on higher energy costs in their selling prices, the latest leap in wholesale gas prices poses an upside risk to our forecast for core CPI inflation to fall to 2% by the start of 2025,” said Ruth Gregory, deputy chief economist at Capital Economics. 

UK gas costs have dropped more than 40% this year but the market is still fragile. Volatility is rife with intraday prices spiking more than 40% in Britain and Europe last week on fears that supply could be restricted by strikes at a key LNG facility in Australia. The possibility of extended cold weather this winter is also is risk for gas supplies.

“As we head into winter, the cost of heating our homes comes back into focus,” Mike Thornton, chief executive at Energy Saving Trust, said. “Energy prices are still high and we may see increases again this winter.”

Europe is still recovering from last year’s energy crisis, when Russian supply cuts left it highly exposed to shifts in the tight global market. A milder winter last year and strong storage levels puts the continent and the UK in a strong position to get through the winter. Energy executives are warning that supply shocks are still possible. 

Before taking into account future price spikes, the dis-inflationary effect from energy prices is already set to slow down, according to George Moran, European Economist at Nomura International Plc.

Since inflation peaked late last year at 11.1% the housing, water and energy component has contributed to 60% of the retreat. However, the economy still a way off the BOE’s target inflation rate of 2%.

At the same time, the energy price cap for households is set to plateau for the next 12 months at just below £2,000, a level that’s still too high for the millions of households that can’t afford to pay their bills. It also means the BOE will have to rely on other inflation components in the Consumer Prices Index to shrink.

The BOE raised its key lending rate to 5.25% earlier this month, a 15-year high, amid the threat from sticky prices and rapidly rising pay. Markets are betting on rates hitting 6% after strong wage data last week that suggests businesses may pass higher costs back to consumers.

(Updates with comment from Capital Economics and Energy Saving Trust)

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