UK CPI: The slow grind higher - ING

James Knightley, Senior Economist at ING, suggests that the UK inflation is starting to creep off its lows and while little change is expected today, falling sterling, rising energy prices and a tight labour market point to future upside risks.

Key Quotes

“Both headline and core UK inflation have been moving higher in recent months, albeit from very low levels, thanks largely to sterling weakness and energy price developments. The tight labour market may also be having an influence (including the implementation of the National Living Wage) while the timing of Easter provided an upside boost to inflation in March through a big jump in apparel and air fares. Consumers are starting to notice higher prices too, with the YouGov Citi April inflation expectations series picking up.

We expect to see stabilisation though for today’s April CPI report (0.5% YoY), thanks in part to a big downward swing in airfares and lagged effects of utility bill price cuts. Nonetheless, we suspect inflation will continue to grind higher in coming months, particularly with petrol prices rising, which will also push up transportation costs and could impact other components through rising distribution costs. In fact we expect inflation to push above 1% before the end of the year, which would help boost the case for an interest rate rise in 1Q17.

This all assumes the UK votes to stay in the EU on 23 June. If it doesn’t then sterling could fall substantially due to worries about economic implications and concern about portfolio and direct investment flows at a time when the UK already has a very significant current account deficit. A 15-20% trade weighted decline in sterling runs the risk of sharply higher imported price inflation that could push consumer price inflation well above the 2% target next year. However, in this instance we suspect that a Bank of England rate cut would be the most likely scenario as authorities seek to shore-up confidence given the uncertain economic environment that the UK would be in. Indeed, the past precedent is 2011 when inflation rose above 5% on energy prices and sterling weakness yet the BoE continued with stimulus due to the poor environment for growth leading to the (correct) assumption that the inflation spike would be temporary.”