The ongoing surge in inflation is largely explained by global supply-chain disruptions and exacerbated by Brexit. We find that the supply-demand mismatch measured by the production shortfall in the manufacturing sector (the difference between new orders and output) is an explanatory factor for core inflation with a lag of four months (see Figure 3). Hence, in August, the production shortfall of May suggests that the inflation due to the supply-demand mismatch stood at +2.3% y/y out of the 3.1% total increase in core inflation. Looking forward, the supply-demand mismatch inflation should reduce to 1.7% y/y in December but remain elevated going forward. Globally, supply-chain disruptions should remain elevated into 2022 and not fully normalize before 2023 . At the same time, Brexit remains a significant hurdle for more than half of
UK importers and exporters. As of October, 60% of importing businesses continue to state that they have faced challenges importing, notably additional paperwork and transportation costs. To add to this, border controls for
UK importers have been delayed to 2022. Overall, we expect a contribution of more than +1pp to headline inflation from supply-chain disruptions in 2022.
In addition, while average earnings growth should slow to 3.5% y/y in 2022 from 5.1% in 2021, Brexit will keep it above 3% beyond 2022. There is clearly a mismatch between demand and supply in the labor market: In August, job vacancies reached a record high (1.1mn persons or 3% of the workforce) and weekly average earnings increased by +7.2% three-month y/y (+4.8% on average excl. Covid-19 and furlough scheme effects). At the same time, there were still 1.1mn people under the furlough scheme. The mismatch could mean that more than 220K are at risk of entering in unemployment as of Q4 since the furlough scheme expired at the end of September. This would mean that the unemployment rate could rise to 5.1% from 4.5% currently – still 0.8pp above pre-crisis levels (and to slow to 4.7% in 2022).
While this should somewhat ease wage pressures in the coming quarters, the problem is that workers on furlough are not suitable for those jobs where demand is high. In addition, there are more inactive people following the Covid-19 crisis who might return to the labor market. And as of mid-2021, incoming foreign workers were still 7% fewer compared to June 2019 (i.e. c.172K work-related visas granted in the year ending June 2021). Wage growth has been above 3% since 2018, a sign that the labor market supply-demand mismatch could last in the absence of a sizeable immigration policy.
Figure 3 – Core inflation vs production shortfalls (new orders – output)