UK: Inflating the Risks? - ING

UK: Inflating the Risks? - ING

11 April 2016, 12:56
Roberto Jacobs

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)

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