Annual inflation rate slows down after energy prices fall

The annual rate of inflation as measured by the Consumer Price Index (CPI) rose 10.1% in March, a slightly slower pace than the 10.4% in February (1).

The sharp decline in wholesale energy prices seen in the last few months is starting to flow through into lower energy bills for businesses and households.

Inflation has been above the Bank of England’s 2% target since May 2021, despite the Bank raising interest rates 11 consecutive times to 4.25%.

The largest contributor to inflation is the cost of energy, which peaked in October 2022 when prices soared by 90%.

The cost of energy did not account for much of CPI prior to October 2021, but since then it has increased in leaps and bounds.

Inflation is expected to drop sharply later this year as gas and electricity prices in wholesale markets have fallen by as much as 85% and 80% respectively since their peak last August (2).

Season ahead (Summer 23) natural gas prices were trading around 110p per therm by the end of March 2023, having hit 726p per therm last August as Russia cut Europe’s gas supplies.

Meanwhile, power prices for Summer 23 were trading at £117/MWh, down from £583/MWh over the same period.

The key drivers behind falling wholesale energy prices include:

• High storage levels in Europe and the UK: European gas tank storage during winter 22/23 remained well above the five-year average of 34% and in early April it was 55% full (3). April marks the end of the heating season and the process of refilling begins ready for next winter. In the UK, storage was at 62% of capacity at the end of the winter, much fuller than usual (4).

• Lower demand: European Union countries’ gas consumption dropped by 18% from August 2022 to March 2023, compared with the five-year average for the same period (5). Consumption was lower than the 15% target set by the Group to limit its reliance on Russian gas. The EU has extended the 15% voluntary demand cut until the end of March 2024. Gas demand in the UK in winter 22/23 was the lowest since at least 2010-11 (6). Industrial and domestic gas consumption declined by 8.2% and 19% respectively in 2022 compared to the previous year with demand destruction accelerating in the last quarter. Businesses and households lowered their consumption to reduce their energy bills.

• Robust gas suppliers from Norway and strong imports of LNG: Norway's pipeline gas exports to continental Europe and the UK remained robust in Q1 2023 (7). Norway is now Europe's biggest single gas supply source after Russian exports were sharply curtailed through 2022. UK LNG imports hit a record high of 25.6 bcm in 2022, up 74% on the previous year (8). The UK holds significant regasification infrastructure, which meant the UK was used as a land-bridge for increased natural gas exports to Europe, while supporting domestic gas demand. In 2022, the US replaced Qatar as the largest trading partner to the UK, supplying half of the country’s LNG imports. In mid-April, National Grid said that the UK will have sufficient gas supply to meet demand from April to September and is expected to sustain flows to Europe (9).

• Mild winter contributes to demand destruction: In addition to record energy prices seen in 2022, which motivated businesses and households to reduce their energy consumption, milder temperatures this winter contributed to demand destruction. During the heating season in the UK, which run from October 2022 to March 2023, the average temperature was 7.5 degrees, slightly lower than the same period a year earlier but higher than the 30-year average of 6.8 degrees (10). This contributed to a reduction in domestic energy demand by 15% year-on-year, whilst industrial energy consumption declined by 6.7% over the same period (11).

(1)Consumer price inflation: March 2023, Office for National Statistics 19 April 2023 https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/march2023

(2)Intercontinental Exchange (ICE) UK natural gas and base electricity future prices for Summer 23, Winter 23, Summer 24 and Winter 24

(3)Europe ends winter with comfortable gas storage, ING Bank 5 April 2023 https://think.ing.com/articles/europe-ends-winter-with-comfortable-gas-storage

(4)European Gas Prices Slide Further as Demand Is Slow to Recover, Bloomberg 6 April 2023 https://www.bloomberg.com/news/articles/2023-04-06/europe-gas-prices-resume-slide-as-demand-remains-muted?leadSource=uverify%20wall

(5)EU cut winter gas use 18%, surpassing energy crisis goal, Reuters 19 April 2023 https://www.reuters.com/business/energy/eu-cut-winter-gas-use-18-surpassing-energy-crisis-goal-2023-04-19/

(6)UK winter local gas demand at 13-year low, Argus Media 3 April 2023 https://www.argusmedia.com/en/news/2435733-uk-winter-local-gas-demand-at-13year-low

(7)Norwegian gas supplies to Europe, UK remain robust in March, S&P Global 4 April 2023 https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/natural-gas/040423-norwegian-gas-supplies-to-europe-uk-remain-robust-in-march

(8)Supply of Liquefied Natural Gas in the UK, 2022, Department for Energy Security and Net Zero 30 March 2023 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1147129/Supply_of_Liquefied_Natural_Gas_in_the_UK__2022.pdf

(9)Britain has enough gas for summer demand, National Gas Transmission says, Reuters 18 April 2023 https://www.reuters.com/business/energy/britain-has-enough-gas-summer-demand-national-gas-transmission-says-2023-04-18/

(10)Climate summaries, Met Office April 2023 https://www.metoffice.gov.uk/research/climate/maps-and-data/summaries/index

(11)Energy Trends October to December 2022, Department for Energy Security and Net Zero 30 March 2023 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1147249/Energy_Trends_March_2023.pdf