Inflation will briefly hit 3.6 per cent this year and “remain well above” the Bank of England’s target until late 2026, according to Oxford Economics.
In a report led by UK economist Edward Allenby outlined the four key drivers of inflation in the upcoming year.
Changes in the Budget
Allenby highlighted the VAT slapped onto private schools, which began in January, had caused a 12.7 per cent rise in private education prices, contributing to a 0.1 percentage point uplift in headline inflation.
Several of Chancellor Rachel Reeves’ key policies from her October Budget will officially come into law in April, including the employers’ national insurance contribution (NIC) hike.
Reeves upped the NIC rate by 1.2 per cent to 15 per cent.
The national living wage is also set to increase in April, rising 6.7 per cent to £12.21 per hour, in what could be another cost sting for employers.
Small and medium-sized businesses are expected to bear the brunt of the Budget’s impact on their cost bases, potentially leading to staff reductions and price hikes.
A strong dollar and weakened sterling
Allenby predicted the weakened stature of the pound against the dollar would be felt harshest on import activity.
He said categories such as food and core goods were likely to be the worst struck, leading to higher prices in the domestic market.
Heightened prices in the UK market could then trigger a chain-reaction across wages, as workers struggle to meet the increasing cost-of-living.
Allenby stated Oxford Economics modelling suggested the “passthrough” of the weaker sterling would be gradual.
This implies the increased prices would hit in one wave, and instead gradually climb over time, which could help drive higher levels of inflation in the long-term.
Sharp rise in regulated prices
As firms pour money into replacing aging infrastructure to meet requirements set by regulator Ofwat, households are set to feel the sting of increased bills.
Water bills are expected to surge 26 per cent on average, or £123 per year, from April 2025.
The increase marks the largest jump since the water industry was privatised.
Allenby said increased water bills will be a key contributor to rising costs of core goods pushing inflation up.
He added: “The surge in European wholesale gas futures prices in December and January means the energy category will push up inflation in the Spring”.
Higher oil prices
The price of fuel plays a significant role in inflation levels due to the impact it has on multiple areas of the economy.
Higher fuel prices increase the cost of transportation, which affects the price of goods and services that rely on transportation.
Allenby said despite recent oil price shifts being smaller than those seen in gas, Brent crude has risen by almost seven per cent on a sterling-adjusted basis since October.
Motorists have felt the effect with unleaded prices up by 4 per cent since October and diesel facing 6 per cent increases for the same period.