Sarah Giarrusso, Investment Strategist at Tilney Smith & Williamson, the wealth management and professional services group, comments on December’s UK CPI inflation data:

UK December annual CPI inflation came in at 5.4% (consensus: 5.2%), against 5.1% in November, the highest figure since March 1992. The underlying core CPI inflation (excluding energy, food, alcohol and tobacco) surprised on the upside at 4.2% (consensus: 3.9%) versus 4.0% previously.

The rise in annual headline inflation was mainly driven by higher food and energy prices. Food and non-alcoholic beverages rose by 4.1% over the year and electricity, gas and other fuels rose by 22.7%. The rate of annual core inflation increased slightly and remains at high levels. The biggest drivers continue to be transportation which includes new and used vehicle prices caused by supply chain disruptions which has shown little signs of abating. Restaurant and hotel prices remain elevated with accommodation services reaching new highs, rising at an annual rate of 15.5%.

Given inflation reached a 30-year high, the Bank of England (BoE) is under pressure to stabilise prices. At the last Monetary Policy Committee meeting in December the BoE decided to raise interest rates from 0.1% to 0.25% despite the uncertainty around the spread of the Omicron variant of COVID. The Bank is likely to raise rates further throughout the year to help bring inflation back down to the 2% target. The economy is in a relatively strong position to weather raising rates as the labour market continues to strengthen. The employment data compiled from HMRC released yesterday showed that in December 184k jobs were created, which is 410k above the pre-pandemic level.

A shortage of workers brought on by the pandemic has caused wage growth to increase. However, after hitting a peak of 8.8% in the three months to June 2021 these wage pressures have eased somewhat. The most recent data showed a slowing in the annual average weekly earnings growth from 4.9% to 4.2%. However, wage rates still remain at elevated levels.

Despite rising input costs including raw materials and wages, company profit margins remain relatively healthy for the UK equity market. The strength of the UK economy is expected to continue with analysts forecasting an annual growth rate of 4.6% for 2022 and 2.5% for 2023 and inflation is expected to fall from highs of 5.6% in Q2 2022 back down to the central bank target of 2% in Q1 2023. This is likely to continue to support company’s earnings and boost optimism for UK equities.