Investment Clock insights

UK inflation – stronger under the surface


Melanie Baker

16 January 2019

Headline Consumer Price Index (CPI) inflation was 2.1%Y, in line with expectations, in December (vs 2.3%Y in November); Retail Price Index (RPI) was weaker than expected at 2.7% after 3.2%Y. With pay growth rising and employment growing, weaker headline inflation should be good news for consumers.  However, with consumer confidence falling and household unemployment expectations rising (presumably not being helped by still high levels of Brexit and political uncertainty)  the risk is that any boost for consumers will end up being saved rather than spent. 
The details show that the main downward drag on the month came from transport (particularly petrol prices and the volatile air fares component).  There were upwards contributions in a number of components, with restaurants and hotels the biggest contributor of upward pressure, helping to explain why core inflation actually ticked up a tenth to 1.9%Y.
More signs of domestically-driven inflation? Breaking the data down by import intensity suggests a bit of a change from last month. The contribution from the most import intensive bit of inflation rose a touch while the contribution from the least intensive bits of inflation fell.  However, our measures of core services inflation rose and, if you look at the contribution to inflation of the two least import intensive categories together, the contribution was stable.
Running further below Bank of England (BoE) forecasts: The BoE staff forecast (at the time of the November Inflation Report) for today’s CPI was 2.4%Y, so there is quite a gap now with their forecasts. However, this will at least partly reflect what has happened to oil prices. In addition, the labour market still looks tight, pay growth is rising and there are other signs of stirring domestic inflationary pressure.  In other words, this undershoot seems unlikely to make much difference to their medium-term views in and of itself.  More likely to have an impact, and increasing the risk that the BoE delay any tightening, are ongoing Brexit uncertainty and, compared to conditions in November, weaker global growth and tighter developed market financial conditions.

Headline Consumer Price Index (CPI) inflation was 2.1%Y, in line with expectations, in December (vs 2.3%Y in November); Retail Price Index (RPI) was weaker than expected at 2.7% after 3.2%Y. With pay growth rising and employment growing, weaker headline inflation should be good news for consumers.  However, with consumer confidence falling and household unemployment expectations rising (presumably not being helped by still high levels of Brexit and political uncertainty)  the risk is that any boost for consumers will end up being saved rather than spent. 

The details show that the main downward drag on the month came from transport (particularly petrol prices and the volatile air fares component).  There were upwards contributions in a number of components, with restaurants and hotels the biggest contributor of upward pressure, helping to explain why core inflation actually ticked up a tenth to 1.9%Y.

More signs of domestically-driven inflation? Breaking the data down by import intensity suggests a bit of a change from last month. The contribution from the most import intensive bit of inflation rose a touch while the contribution from the least intensive bits of inflation fell. However, our measures of core services inflation rose and, if you look at the contribution to inflation of the two least import intensive categories together, the contribution was stable.

Running further below Bank of England (BoE) forecasts: The BoE staff forecast (at the time of the November Inflation Report) for today’s CPI was 2.4%Y, so there is quite a gap now with their forecasts. However, this will at least partly reflect what has happened to oil prices. In addition, the labour market still looks tight, pay growth is rising and there are other signs of stirring domestic inflationary pressure.  In other words, this undershoot seems unlikely to make much difference to their medium-term views in and of itself.  More likely to have an impact, and increasing the risk that the BoE delay any tightening, are ongoing Brexit uncertainty and, compared to conditions in November, weaker global growth and tighter developed market financial conditions.

Source: ONS as at 31 December 2018

Source: ONS, RLAM Economics as at 31 December 2018

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.