UK: Inflating the Risks? - ING
James Knightley, Senior Economist at ING, suggests that the UK headline
inflation is likely to stay low in the near term, but with sterling
having plunged and commodity prices nudging higher, imported inflation
could rise sharply in 2H16.
Key Quotes
“This
week’s UK inflation data is unlikely to rock the boat too much. We look
for a modest tick higher in the annual rate of inflation to 0.4% YoY
from 0.3% in February. On the one hand, higher petrol pump prices will
exert an upward influence, but we also have to remember that utility
bill prices were cut last month. Then we have to consider the impact of
the 11% fall in sterling on a trade-weighted basis since mid-November,
which is likely to push up the cost of imported products and resources.
Furthermore, we see evidence to suggest that the effects of the
supermarket price war are waning in terms of the deflationary influence
on food prices. Producer price inflation is also becoming less
deflationary, which suggests that the gap between service sector
inflation (+2.5% YoY) and goods price inflation (-1.5% YoY) is likely to
narrow.
A complicating factor is the Brexit vote – the
referendum on ongoing EU membership that will be held on 23 June. There
are signs that this is already making corporates nervous with a recent
survey by Deloitte, the financial services firm, suggesting that
businesses are already pulling back on investment and hiring. This could
take some inflation pressures out of the economy.
That said, if
the UK votes to stay in the EU then we look for hiring and investment to
reaccelerate in 2H16. Given there are currently more job vacancies than
there are people claiming unemployment benefits, this clearly suggests
that the labour market is very tight. We therefore look for wage
pressures to gradually build, a process that may actually be helped by
higher headline inflation. This then offers greater justification to
workers to push for higher pay.
So, with imported prices set to
exert an upward influence and domestic labour costs likely to do the
same, we see potential for headline CPI to pick up quickly in 2H16.
Indeed, we would not be surprised to see it average 1.5% YoY in 4Q16.
For now, financial markets are pricing an incredibly flat outlook for
the Bank of England policy rate, which reflects the broad risks for
rates – if Brexit happen then the BoE may have to cut rates to shore-up
confidence. However, if we are right in thinking that the UK narrowly
votes to stay in the EU then this rising inflation backdrop could be the
catalyst for a swift change in BoE rhetoric. As such, we stick with our
call for a November 2016 rate rise from the BoE.”
(Market News Provided by FXstreet)
