Inflation figures suggest no Brexit effect. Is that really the case?

Brexit effect? What Brexit effect? That is the obvious way of assessing the official inflation figures for July – the first to cover changes in prices for a period that fell entirely after the 23 June referendum.

But appearances can be deceptive. Scratch a little beneath the surface and it is clear the UK’s decision to leave the EU had an impact on inflation last month.

The effect came via the sharp depreciation of the pound, which was trading at just under $1.50 before the referendum to a low of just under $1.28 in early July. The cost of imports goes up when sterling goes down.

Given the UK’s record balance of payments deficit, the pound was going to fall eventually no matter what the result of the referendum. But a combination of shock, panic and uncertainty meant it came down a lot more rapidly than anybody was expecting.

This fall manifested itself in two ways. A breakdown of the Consumer Prices Index – the government’s preferred measure of the cost of living – showed that dearer imported food and fuel were among the reasons for the slight pick up in the annual rise in inflation from 0.5% to 0.6%.

But the real place to look for the Brexit effect was the Producer Prices Index, published by the Office for National Statistics at the same time as the CPI. The PPI shows how much UK firms are paying for their fuel and raw materials, and how much they charge for goods as they leave the factory gate. As such, it is a good guide to inflation coming down the pipeline.

In the year to July, the prices paid by UK industry for fuel and raw materials were 4.3% higher than a year earlier, a big turnaround from the 0.5% fall in the year to June. Factory gate prices, down 0.2% in the year to June, were rising at an annual rate of 0.3% in July - the first increase in two years.

So what happens now? The post-Brexit panic selling of sterling is over but the pound still looks a sell. That’s because the Bank of England has made it clear it is less bothered about the prospect of inflation rising over the coming months than it is about growth and unemployment. In all probability, there will be a further cut in interest rates and there may be another dollop of quantitative easing. Both will weaken sterling, pushing CPI inflation above its 2% target next year.

The spurt in inflation is likely to be temporary. Rising prices are unlikely to be matched by rising wages, leading to a squeeze on spending power that will prevent manufacturers and retailers passing on their higher costs to consumers. The immediate impact of the falling pound is inflationary but its longer-term impact is deflationary. As a result, the Bank is right not to let sterling affect its post-Brexit policy stance.