Weighing in on inflation

At LGIM, Thursday once started early at the Bloomberg terminal and ended at the Globe, our beloved local pub. The pandemic, however, hit us all where it hurts the most – and just to clarify, Bloomberg access is not the casualty here.

COVID-19 and shifts in spending

Every year, the Office for National Statistics updates the weights of goods and services underpinning the headline inflation indices (RPI, CPI and CPIH), to account for changes in consumer spending patterns. In a typical year (i.e. not 2020) this is a minor event for market participants, since expenditure tends to remain broadly constant from one year to the next.

Figure 1 shows the changes[1] in item weights for CPIH for 2021, based on expenditure data from 2019 and 2020. Unlike a normal year, there have been significant changes, with the proportion of our spending increasing most on education, clothing and food, while – as you may anticipate – we spent less on restaurants and hotels, cultural events and transport.

The impact on RPI was less pronounced than for CPIH, as it follows a slightly different methodology when calculating the basket weights. Most notably, the weights for RPI cover a time period that was impacted less by the pandemic.

On a more granular level, there have been some noteworthy changes to the underlying items included in the indices. A number of new additions capture how our lifestyles have changed under COVID-19 lockdowns, for example handheld weights for home exercise, casual clothing items for working from home, and hand sanitiser gel.

Less pandemic-related but of interest nonetheless, hybrid and electric cars are also amongst the new items, reflecting a growing trend towards these types of vehicles, a shift supported by UK government’s long-term commitments towards net-zero emissions. 

Seasonality

Inflation is highly seasonal, which means that changes in prices tend to follow a similar pattern each year. For example, prices for clothing tend to drop during winter and summer sales (between December and January, and May and July), while in between these periods prices usually rise – when the real fashionistas come out.

Unsurprisingly, the pandemic has also influenced these normal seasonal patterns. Figure 2 shows the seasonal price movements for clothing and footwear over the years; 2020 clearly breaks the pattern.

Looking ahead

In our view, even though these changes indicate a significant shift in consumption in the short term, it is not clear whether these patterns will persist post-pandemic. Based on the Bank of England’s latest CPI projections, the variability of outcomes is wide and has increased noticeably, compared with three years ago.

Perhaps this will be another topic for a future Thursday night discussion at the Globe. But for now, we’ll continue sharing our thoughts on inflation here on this blog.

[1] Note, weights are a relative measure and a change in weight in one area will cause a relative weight reallocation in other areas. For example, the increase in weight for education is driven by both an increase in underlying expenditure as well as a reallocation effect, i.e. education makes up a relatively bigger proportion of the household budget as total household spend fell during the pandemic.