Core Blimey! Why Britons should look beneath headline inflation

May 20, 2015

???????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????We all now know by now that British inflation has dipped to slightly less than zero, its weakest since 1960. Much of the recent weakness is down to the same reason inflation is so low in the euro zone, Britain’s main trading partner: the collapse in the price of oil.

What hasn’t turned many heads is that Britain — still world-famous as a place that can easily charge you a hefty price for a service you didn’t even know you received — isn’t generating the same amount of inflation as it once did on its own.

Put more bluntly, “Rip-off” Britain now is struggling to rip itself off.

The jury may still be out on that conclusion for many a suburban rail commuter. But the latest official data, which were driven down by a sharp fall in airfares, suggest at least an ongoing great moderation in services inflation. In the short term, that may be very good for consumers.

UK goods vs services inflationEconomists at Fathom Consulting, who have direct experience with the BoE’s inflation models, reckon that at a record low of 2 percent, services inflation is 1.4 percentage point short of where it ought to be in order to meet the bank’s inflation target.

Why should services inflation normally be running well above the 2 percent target? Partly because productivity, which is in a state of crisis in Britain, tends to be higher in production of goods rather than services. That leaves services companies more at ease charging higher prices for whatever services they provide – or don’t provide, like hefty fees for something you ordered all by yourself on a website.

The steep fall in goods inflation and the more modest decline in services inflation are pulling down core inflation, now at 0.8 percent.

UK inflation vs core













In the euro zone, core inflation is almost the same: 0.7 percent.

The problem of course is that while many central banks, like the Bank of Japan and the Bank of Canada, do target measures of core inflation, the BoE does not.

Rate-setters may “look through” the inevitable rise in inflation once the base effect drives a higher year-on-year comparison now that oil prices have bounced off their lows. But there is a chance that a policymaker who may be pre-disposed to get rates off a record low might not, and instead vote for a hike.

Much depends on whether or not the economy accelerates again after a poor first quarter of just 0.3 percent growth. The latest Reuters consensus predicts a rebound to 0.7 percent growth for the next three quarters, slowing only to 0.6 percent through to the third quarter of 2016.

Fathom economists, who don’t expect a rate hike until 2017, reckon growth won’t rebound:

The official view seems to be that core inflation will pick up, if not later this year then through next year, as a period of healthy UK economic growth puts upward pressure on wages, and then prices. But will it?

Growth of just 0.3% in 2015 Q1 was not a ‘blip’ in our view, but a return to the new normal. Our own forecast is for growth of 1.9% in 2015, slowing to 1.3% in 2016. This is not an environment in which we expect to see significant upward pressure on wages.

For the moment, this is the immediate dilemma facing the Fed, with an unemployment rate low enough to warrant much more wage inflation at this stage but with a set of dismal U.S. first quarter data that so far nobody has been able to explain away clearly. A strong rebound there is still far from certain.

UK policy rate expectationsIn Britain, economists are still clinging on to hopes for a hike in the first quarter of next year. But with just a 60 percent probability of that happening in their view, those hopes are fading.


No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see