Inflation myths: the surge that never came

In “Deficits, gilts and the cost of living: more myth busting” I wrote about what I believe is driving US and UK bond yields higher in 2026, namely a pick-up in inflation, but highlighted that ten-year yields were still below where you might expect them to trade given the Fed funds rate is at 3.75%. The note also showed why the popular narrative about what is driving higher US bond yields, namely a larger deficit, is not the catalyst that so many believe in. Indeed, the note showed, to the extent that there is a relationship between the size of the deficit and bond yields, that it is slightly inverse. In other words, higher deficits, remarkably, have loosely correlated with lower bond yields.

This note, whilst building on that piece, is designed to cover a different but related topic, which is the outlook for inflation. I wanted to cover this topic again not just because it is so obviously fundamental to our economic existence, but also because there appears to be a growing and vocal consensus building, as Jeremy Warner argued in an article published recently in the Telegraph, that “we have entered another inflationary age”. It is a viewpoint with which I strongly disagree.

Watch · S2 Ep 10Watch The Show where we covered this topic

Mr Warner is not alone at the Daily Telegraph. Another of its economics commentators has gone even further by stating in a recent article that “Britain’s inflation is about to soar”. In this piece, Liam Halligan references the war in the Persian Gulf as the main culprit but also talks about water shortages, crop yields, severe weather and the war in Europe as other factors that will help to drive inflation to “4-5% or even more” by the year end. This opinion piece (it is rather lacking in facts and data that would support this claim) is not unique, and joins a long list of journalistic and academic economic commentary that tends to point in the same direction.

This whole subject became even more topical last weekend at the Jackson Hole symposium of central bankers, when the new Fed chairman, Kevin Warsh, who is not keen on steering the market, commented that elevated inflation was his number one concern right now and that interest rates could move higher if more progress isn’t made on getting it down. Without pandering to the market’s rather needy wish to be guided as to what to expect, in the form of forward guidance, verbal cues about the Fed’s intentions, the Fed’s “reaction function” or specifics about the economic signals that would trigger a rate adjustment, what he did say was significant: “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.” (The objective is 2%.)

I think this is what the fixed interest markets wanted to hear and, given the prevailing consensus, not surprisingly the fact that yields moved a bit higher was seen as the result of the probability of a rate hike later this month increasing. This most recent increase in ten-year yields over the last week or so of August was, however, in my opinion much more to do with heightened tension in the conflict between Iran and the US, the most recent exchange of fire and the concomitant pick-up in the oil price. Although I can’t prove it, the chart below shows very clearly that the ten-year bond yield started its ascent on the day the war started and has been pretty sensitive to increased and lower oil market tension ever since.

Two claims, both wrong

There are two arguments about inflation here which I need to address. The first is that inflation is about to rip in the UK, as described by Liam Halligan in the Telegraph, and the second is that “we have entered a new inflationary age”, as outlined by Mr Halligan’s colleague Jeremy Warner and a whole host of commentators and academics who appear to believe the same thing.

For the record, I strongly disagree with both.

The first is the easier to refute, and I have been writing consistently about this all year, especially since the war broke out at the end of February. The consensus on this subject, let’s not forget, has been wrong all year on inflation. Following the outbreak of the war and the initial stress in the oil price, which peaked just under $120 a barrel, this is the sort of commentary we saw in the subsequent weeks:

• “Brace for impact”, said Deutsche Bank’s chief UK economist in late March. “Inflation is poised for another unwelcome detour.”
• The chief economist of the ICAEW, the Institute of Chartered Accountants in England and Wales, said “a brutal inflation surge” was coming: skyrocketing oil and gas costs were likely to lift the headline rate above 4% by the summer.
• Oxford Economics, on the view that oil prices might average $140 for two months, forecast global inflation rising to 5.8%.
• The Economics Observatory, which includes “prominent academics” from the LSE, NIESR, Cambridge and Oxford Universities, Imperial College and UCL amongst others, forecast the following, and rather like the Bank of England it based its views on three scenarios, in this case good, bad and ugly. You will see that the best scenario saw UK inflation peaking at over 4% in the early part of 2027 and the ugly one saw inflation peaking at nearly 7% around the same time. This forecast, by the way, was published in June this year.

The Economics Observatory was not alone in this scenario setting, as I have said. The Bank of England also abandoned its central forecast in its April Monetary Policy Report and produced three scenarios along similar lines: mild, moderate and worst case. In its most optimistic scenario it had inflation, as measured by the CPI, at 3.6% by the year end. In July, by the way, it was 2.9%.

As I have written throughout the summer, these forecasts were in my opinion way too bearish and, as the chart below shows, I was, well, right. Instead of increasing through the spring and summer months, inflation actually fell. Consensus was not only way too bearish but directionally wrong. So, to summarise: against a backdrop of what the IEA described as “the most severe oil supply shock in history”, UK inflation has FALLEN in 2026. In fact, as you can also see from the chart, despite the war and the worst energy shock blah blah, UK inflation in 2026 is lower than it was before the war in 2025.

What the consensus got wrong

This outcome of course poses the question: what did consensus get so badly wrong? And the next logical one is, if inflation didn’t “surge brutally” after the war started, whilst oil prices were above those prevailing now, what might prompt Mr Halligan to expect it to do so now?

This is a hard series of questions to answer, but I suspect there is a common culprit here that I have written about before, and that is what I have called the ghostly “second round effects” so loved by central bankers and academics. In summary, these are the downstream effects of an energy price shock which theory suggests follow on from the initial shock, and include things like workers demanding higher wages to maintain real wage rates and businesses raising prices to protect margins as costs rise.

The models that all academics and central bankers rely on (rather than common sense) will all undoubtedly factor these effects into their predictions of what happens after an energy price shock.

My point back in the spring, when I first wrote about this, was that these second round effects, whilst prominent in the models, were totally absent in the reality of the UK economy, which has witnessed all year a deteriorating labour market, collapsing vacancies and falling pay growth, which in the private sector is now running at 2.8%, the weakest since 2020.

It is also obvious to anyone paying attention that raising prices in an intensely competitive economy like the UK’s is not easy, and frankly not possible for most businesses. In most cases businesses have to adjust for higher costs by becoming more efficient (reflected in better productivity outcomes which, surprise, surprise, we are also now seeing) or by accepting lower margins. It is only in the public sector, or in privatised monopolies, where inflation-linked price increases are the norm.

Food, weights and what energy really costs

This is perhaps best represented by what has happened to food prices this year. When war broke out and the inflation script was being written by the consensus, food prices were expected to be the first to increase following higher energy costs. In fact, food prices have actually fallen in 2026 (from where they were in December), and year on year food price inflation is now down to 1.3% in July (food and non-alcoholic beverages).

Although I suspect that food prices will now start to pick up a bit, this was an outcome no one was talking about last February, but it reflects, in part, the reality of an intensely competitive food retail industry here in the UK.

One other thing to bear in mind is the weights attaching to different items in the CPI basket. Although gas and electricity prices grab a lot of headlines in the media, their weights in the CPI basket are much lower than they used to be, which I am pretty sure sits at odds with the popular cost of living crisis narrative. In fact, at 32, they are currently about half of the level in the late 1980s, as can be seen in the chart below, and not far off the 38-year low of 26 in 2004. (That is parts per 1,000, so equivalent to 3.2% currently.)

By the way, this compares with a food and non-alcoholic beverages weight of 11%.

What may also surprise you is that even in an economy where consumer energy prices adjust quickly to commodity price changes, the unit price of gas will have risen by only 4% on average in 2026 on 2025 and the unit price of electricity by only 1%. (That is for the full year, now that we know the price cap for October to December 2026.)

Finally, whilst I am firing a lot of data at you, I thought the following might also be very interesting, given its relevance to the issues I am addressing in this note.

That is a lot of data, and so I will summarise:

• In 2023 prices, so in effect in real terms, total spending by households on gas, electricity and road fuel has fallen since 2011 by about 14%.
• Spending on fuel is down a bit (3%), despite big increases in fuel taxation over this period, reflecting changes in technology (more fuel-efficient cars and the arrival of hybrids and EVs).
• Notably, spending on gas is down very significantly, by about a third since 2011.
• Spending on electricity, despite more efficient household appliances and lighting, better insulation and a significant fall in annual consumption, has fallen by a much more modest 11%. In fact, although I can’t find the exact matching data, annual electricity consumption per UK household dropped by 26% between 2007 and 2023.

Why I don’t expect it now

In conclusion on this first issue, my guess is that the academics’ and central bankers’ models told them something which turned out not to be true, but which a dose of common sense and judgement might have done. As for the inflation surge folk like Mr Halligan expect between now and the year end, my judgement is that they too will be proved wrong.

I think Mr Halligan, for example, would not know about the weights attaching to gas and electricity, nor that the prices are now known for the full year. Neither, I suspect, would he know that transport fuels (diesel and petrol) are under 3% of the CPI basket, and that tax accounts for about half of the pump price.

I do acknowledge that it is likely that food prices will pick up a bit between now and the year end, and so will inflation from its current 2.9%, but to suggest it will reach 4–5% by the end of the year is frankly alarmist nonsense. I accept that rising tension in the war between the US and Iran has been reflected in higher oil and gas prices, but given what I am reading and seeing, I do not see energy prices moving considerably higher than they are now (around $94 per barrel). This is not because I have some kind of unique crystal ball on what happens next in this conflict, but because I am listening to what Saudi, the UAE, Kuwait and Qatar, for example, along with the US energy secretary, are saying about how much oil and gas they are able to get out of the Gulf by ship, by pipeline or via the Red Sea.

As I have written on numerous occasions recently, my conclusion is that we are well past the point of maximum Iranian leverage on global energy prices.

The new inflationary age that isn’t

Which brings me to the second part of this story, which is the claim that we have entered a new “inflation era”, which appears to be so fashionable now that US and UK government bond yields have risen to levels which look uncomfortable and which many commentators see as a lead indicator of some kind of new systemic inflation challenge. I don’t share this view. In fact, I think the future is going to be characterised by strong disinflationary, if not deflationary, forces which I believe are already visible, but which are camouflaged by the current spike in global energy prices, which is in turn driving bond yields higher.

The TelegraphThe US government is now as risky an investment as AIThis epic bond market rout shows investors are losing confidence in countries’ ability to repay their debts.

In his recent article on this subject, Jeremy Warner from the Telegraph said that this new inflationary era was going to be triggered by a number of factors, the most obvious of which were the “gathering backlash” against globalisation and heightened geopolitical instability, which he went on to say were showing every sign of spiralling out of control. He then added that the upshot was a bond market rout of epic and global proportions. Rather like his colleague at the Telegraph, Mr Halligan, my sense is that this is another dose of journalistic bluster and nonsense which is not based on quantifiable facts.

Let’s take the globalisation backlash issue first. Whilst I can see, and indeed have read, a lot of articles about this, the reality is that global trade volumes have continued to expand, and indeed posted very strong growth in 2025, the year in which Mr Trump launched his global tariff war. Goods trade grew by 6.5% last year and services grew by 9%, in both cases outstripping global GDP growth of 3.2% according to the OECD.

Interestingly, the UN provides another similar chart, which shows that as a percentage of global GDP trade flows also grew in 2025. I thought the commentary was quite telling. The UN’s own caption states that the trade to GDP ratio “rebounds in 2025 after two years of deglobalization”. What isn’t mentioned here is that from its peak in 2011 to 2020 this ratio fell by 13%, but I don’t recall this being attributed to deglobalisation at the time.

Whilst researching for this piece I rummaged around some nauseatingly pompous articles and commentary from the WEF. Here is an interesting quote from a summary piece focused on the WEF’s preoccupation with this subject:

Since then, global trade as a percentage of global GDP has increased by about 13%. So much for deglobalisation or, as Jeremy Warner puts it, the “growing backlash” against it.

My summary is that this unsubstantiated guff is all about politics and is not fact based. Since Covid, global trade in goods and services as a percentage of global GDP has increased by about 16%, despite the setback that followed the first major war in Europe in 75 years. On this evidence, globalisation appears to be alive and kicking!

As for Jeremy Warner’s second reason, which is growing geopolitical instability, which he also claims is “spiralling out of control”, I am not so sure. Although I have been lucky enough to live through a period of history, unlike my father’s generation and his father’s, that hasn’t required me to go to war, I have lived through the potentially global existential crisis that was the cold war, Vietnam, umpteen middle eastern conflicts, the war on terror, the global war on a virus and the ongoing Ukraine conflict. In relative terms, albeit that so many lose sight of this every day, we are right now blessed with relative calm, which I believe is reflected in the buoyancy of global equity markets.

Consequently, I struggle to align the reality of what is going on in the global economy with this alarmist, unquantifiable rhetoric so loved by so many journalists.

Three causes of inflation, none of them present

As for the inflation debate, which is where this piece started, I want to make a couple of economic points before concluding. Historically, inflation problems in the UK, and arguably elsewhere across the developed world, have been caused by one of three factors that have at times coincided with each other:

1. Energy price shocks which have led to policy errors.
2. Excessive and sustained credit growth.
3. Prolonged and excessive wage inflation.

I have written extensively on all these topics in recent months, but suffice to say here that I don’t see any of these problems looming on the economic horizon. Yes, we have had an energy price shock this year, but it has been relatively muted and has coincided with falling inflation in the UK.

Although I have issues with the MPC, it has at least not panicked unnecessarily in the face of that rather muted shock, and neither has the Fed. The ECB has wobbled and made a bad decision to raise rates, but this is from a very low level and won’t, in my view, make a significant difference to either EU inflation or EU growth.

There is no evidence that I can see of excessive credit growth anywhere, and especially not in the US, nor in the UK where, for example, mortgage lending growth is ticking along at 3.6%. (In the ten years that led up to the financial crisis, mortgage lending grew by 10% a year in every year, by way of comparison.) Whilst the extensive package of global bank regulation that was put in place after the financial crisis remains in place, it is very hard to see how the sort of excessive credit growth that has in the past led to high inflation and significant policy tightening could be repeated anywhere.

Finally, in the US, in the UK and indeed across the EU there is no sign of excessive wage growth either. In the US and in the EU private sector wages are growing at about 3.5%, and in the UK private sector pay growth is running at 2.8%, its weakest since 2020. Labour market weakness pretty much everywhere will keep a lid on wage growth for the foreseeable future and, as I will argue below, if anything I see the challenges confronting labour markets exerting further downward pressure on wages.

The disinflationary case

So, if like me you can’t see the catalysts that will be driving a “new era of inflation”, what is the evidence that supports a future with lower inflation, if not deflation? This is again a topic I have covered in previous notes. In summary, my view is that there are three deflationary forces at work, one of which is temporarily suspended. They are:

1. Lower energy prices.
2. Goods price deflation.
3. AI’s profoundly important influence on productivity and inflation.

Whilst the oil price is currently elevated, as is the gas price, for obvious reasons, the outlook for the medium and long term future of the energy market is in my view one characterised by lower fossil fuel prices.

I have written about this in previous notes, but suffice to say that increasing oil output from producers who have a stated objective to increase production, including for example the UAE, Venezuela, Brazil, Iraq, Canada, Mexico and Norway, combined with the potential break-up of OPEC and Saudi’s market share grab, combined with eventual peace in Ukraine and in Iran, combined with a flat outlook for demand, will inevitably mean lower prices. (The list of countries aiming to increase gas production is even longer.)

As for traded goods, China is continuing to export deflation through its currency and through its excess capacity across many industries. This is best represented in the car market, where Chinese manufacturers are increasing their global market share at price points existing manufacturers are struggling to compete with, and with quality standards established industry players can’t match.

Finally, and probably most significantly in my opinion, AI and robot technology will transform productivity across every industrial and commercial sector of the economy. This is already evident in the professional services sector, and most obvious in the vast software industry. Higher productivity is by definition an increase in effective supply, and by definition, therefore, disinflationary.

Once humanoid robots start to be deployed across industry, given that robots don’t get paid and can work 24 hours a day, they will also deliver productivity gains which will also be disinflationary, potentially deflationary. Longer term, automation will inevitably pose all sorts of societal challenges, but on the journey to that point the productivity gains will be transformational in my view. The tentative early signs of that are, I believe, visible already in the recalculation of the UK’s productivity data, which I wrote about last week.

Abundance, not inflation

So, to conclude another marathon. Currently, the academic economic consensus and the financial media seem to have formed some kind of weird alliance that is convinced the world is confronting a new inflation era. I find their arguments, which appear to be motivated by crowded and aligned political agendas, to be totally unconvincing.

Indeed, when I peer into the future, which I accept is pregnant with uncertainty, I am as convinced as they appear to be that the opposite is true. The challenge of the future for policy makers is how to contend with abundance, both of energy and of potential supply, but certainly not of credit, and what they will do to cope with falling prices and an under-utilised workforce.

These are not trivial, but they have quite different implications from the ones the consensus is currently wedded to.