Britain’s Inflation Fears Can Be Found in Its Pubs and Cafes

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(Bloomberg) — Britons’ enduring appetite for dining out, movies and other indulgences is giving services companies the power to keep raising prices, creating a headache for inflation-fighters at the Bank of England.

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In the aftermath of the pandemic, goods were the main source of inflation in the UK as supply disruptions and pent-up demand lifted prices of everything from cars to computers. Now, however, people have shifted from buying things to doing things.

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While inflation in core goods is running at just 1.1% a year, pubs, cinemas, restaurants and hair salons continue to get away with price rises of over 4% — more than double the BOE’s overall inflation target.

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Such punchy increases are allowing many services firms to cope with higher taxes, minimum-wage hikes and stricter employment rules, long after economists thought they would run into consumer resistance. The worry is that they can use that pricing power to shift some of the Iran war impact onto consumers, turning the BOE’s fears of second-round effects into reality.

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“Holidays and leisure have become almost non-negotiable for many households, even when finances are under pressure,” said Richard Lim, chief executive officer of Retail Economics.

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Households are increasingly prioritizing going out and wellness over furniture or jewelery, and are willing to pay. Office for National Statistics figures show that families spent more in real terms on services last year than before Covid, while spending on goods remains below 2019 levels.

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Bruna Skarica, chief UK economist at Morgan Stanley, had expected inflation in the hospitality sector to ease closer to 4%. Instead, companies trying to defend profits margins are showing they can make big price increases stick.

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“If these companies have high pricing power, they’ll have healthier margins, they’ll be able to provide healthier pay settlements, and then you have a cycle of second-round effects playing out,” Skarica said.

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Firms’ ability to raise prices is set to deepen divisions among BOE officials over whether to lift interest rates. Some such as Chief Economist Huw Pill worry that companies will pass on higher energy and raw-material costs triggered by the Middle East conflict, while others including Governor Andrew Bailey appear more concerned about weak demand.

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Investors expect rates to remain unchanged at 3.75% when the BOE announces its next policy decision on June 18, but are fully pricing in one increase this year and see a second as a strong possibility.

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Consumers are starting to get used to faster price rises. Services inflation has been running at an average of 4.5% over the last 12 months, keeping overall price growth too hot for comfort. Inflation dropped below 3% in April for the first time in over a year but the relief is expected to prove temporary. 

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Recent McKinsey & Co. research shared with Bloomberg shows that UK consumers are planning to cut back more on discretionary goods than services over the next three months.