Analyzing UK Price Changes: Insights from Consumer Data

Lennart Brandt, Natalie Burr and Krisztian Gado

In assessing the UK's inflation landscape, the Bank of England has set a target annual inflation rate of 2%, using the Office for National Statistics (ONS) consumer prices index as a benchmark. However, an analysis of data across 700 item categories reveals a nuanced reality: prices rarely shift by exactly 2%. Month-on-month data illustrates that, on average, only about 20% of prices change at all. This phenomenon aligns with the concept of 'sticky prices', where an item's price remains constant for extended periods before undergoing significant adjustments. Recent data shows a noticeable disruption in price behavior beginning in the first quarter of 2022, with only partial stabilization observed since then.

Theoretical Background on Price Dynamics

The understanding of price-setting is crucial for the operation of central banks. Traditional economic models often apply time-dependent pricing models — where firms set prices for predetermined periods (as seen in Taylor's model from 1980) or stochastic timeframes that introduce variability in price settings (Calvo’s approach in 1983). Additionally, state-dependent pricing has gained attention, indicating that price adjustments depend not just on elapsed time since a last change, but also on deviations from a preferred price level. Recent feedback from firms participating in the Decision Maker Panel suggests a shift from fixed to variable pricing strategies, particularly post-inflation shocks. This transition implies that a significant economic shock can escalate the frequency of price adjustments, increasing the immediacy of pass-through effects on overall inflation.

Exploring CPI Microdata

To delve into the price-setting behavior of firms, we utilized CPI microdata from the ONS, covering the period from 1996 through September 2023. This dataset, updated monthly, includes over 30 million observations reflecting the price quotes of more than 700 items, categorized by shop type and geographic location. Our rigorous analysis for identifying price changes requires confirmation of the same item being recorded across two successive months. For example, if a bag of potatoes was priced at £2 in January and £3 in March, but no price data was available for February, we omit this instance from consideration to maintain accuracy.

Key Observations from the Microdata

The initial examination of this extensive dataset reveals several stylized facts regarding price fluctuations. In Chart 1, we observe the month-on-month changes across all items recorded in the dataset. Key takeaways include:

1. A significant majority of prices, approximately 80%, remain stable month-on-month based on historical data since 1996 (illustrated in blue).
2. Since 2021, the proportion of rising prices (in green) has markedly increased, unparalleled by previous patterns during inflationary phases (disregarding VAT adjustments).
3. While the share of decreasing prices (in red) has stabilized since 2021, it remains lower than historical averages, indicating that the predominant adjustment has occurred through rising prices.
4. Noteworthy is the recent dip in the rising prices share; however, it continues to exceed historical norms.

Chart 1: Decomposition of Price Movements Month-on-Month

Importantly, the data indicates that not all prices remain unchanged uniformly. An item that maintains its price from one month to the next may subsequently experience an increase or decrease, causing shifts among the aforementioned categories. Thus, although we observe that only about 20% of goods and services contribute to monthly overall price dynamics, the recent trend showcases a significant movement of prices from stable states to rising ones. This shift mirrors historical patterns typically associated with VAT adjustments during periods such as 2008, 2010, and 2011, rather than a mere spike.

Price Changes Distribution Analysis

A deeper analysis of price changes from 2019 through the present offers further clarity on this phenomenon. Chart 2 reflects the distribution of price fluctuations, revealing that from 2021-2022, we encountered a disproportionate number of firms adjusting prices upward, while downward price changes remained relatively stable.

Chart 2: Distribution of Price Changes by Quarter From 2019

Chart notes clarify that these densities have been normalized to account for the month-on-month changes within the corresponding quarters. Throughout the higher inflation periods, particularly those aligned with target CPI fluctuations, the shape of this distribution remained relatively symmetric, indicating a balance between significant price increases and reductions. However, the current data suggests a growing deviation from this symmetry, with a notable concentration of significant price increases.

Trends in Price Change Densities

In Chart 3, we juxtapose densities from Q3 2022 and Q3 2023 against an average from the pre-COVID era for further insights.

Chart 3: Densities of Price Changes Compared to Pre-COVID Average

These comparisons reveal the stark differences in pricing behavior under high inflation conditions versus historical averages. The sharp uptick in price changes during 2022 was notably absent in the lower segment of price reductions, which remained largely unchanged. However, recent patterns indicate that while the proportion of prices rising has started to decrease, the modal price increase appears stable at around 6%, dwarfing the pre-COVID average of approximately 3%.

Conclusion and Future Directions

In conclusion, the analysis highlights a significant discontinuity in price-setting behaviors, particularly observable post-Q1 2022—a period marked by unprecedented challenges, including surging energy costs and supply chain disruptions following the COVID-19 pandemic. This shift has led to a rebalancing in how often prices increase across diverse products, marking a departure from all prior instances of inflationary behavior within available historical frameworks. Despite some early signs of stabilization toward historical norms in current data, further investigation is essential to decipher the underlying causes of this pronounced alteration in price dynamics on both micro and macro levels.

A continued observation of how these trends evolve is crucial for economists and policymakers alike, particularly as they navigate the turbulent inflation landscape.

Lennart Brandt and Natalie Burr work in the Bank’s External MPC Unit, while Krisztian Gado is a PhD candidate at Brandeis University.

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