UK inflation: core is not yet more

August 18, 2015

The surprise rise in British inflation from zero to 0.1 percent and core inflation by 0.4 percentage point to 1.2 percent in July supports the view rates soon must go up – and also it doesn’t.

UK inflation - headline vs core

Depending on who you read, underlying price pressures are picking up in the economy and will give policymakers added confidence they will need to tighten policy; or the data are mainly down to a seasonal timing issue over discounting of clothing and footwear; or on the whole the numbers still suggest widespread disinflation pressures in the economy and so tell us little about the timing of the first rate hike.

Daniel Verazza, UK Economist, UniCredit:

Core inflation now lies above its 1999-2007 average of 1.1% when the Bank Rate averaged 4.8%. In the last few months MPC members have attached particular importance to measures of core inflation as they look-through the temporary impact of the fall in energy and food prices. Indeed, in July (Bank of England Governor Mark) Carney listed a rise in core inflation as one of three pre-conditions  for rate hikes.

George Buckley, UK Economist, Deutsche Bank:

With core output prices also up in July these numbers won’t be missed by the BoE; the outlook for domestically generated price inflation will be key to when the first rate hike is delivered.

Alan Clarke, head of European Fixed Income Strategy, Scotiabank:

The BoE are focusing more heavily on domestically generated inflation and core inflation – and there are two clear signs of upward pressure here – clothing and airfares. The latter is striking because oil is 50% cheaper than a year ago yet airfares are up. We need another month or two to confirm that this was not a one off, but so far so good.

Allan Monks, Economist, J.P. Morgan:

One tenth of the rise in core came from transport services and around two tenths came from a spike in clothing and footwear inflation. Both of these components can be volatile (especially for clothing during the summer months, where we had anticipated some rebound in July). This warrants some caution when interpreting the move up in core inflation. Even if these moves are not unwound in August, the July gains may be a false signal about where the momentum in core inflation is currently.

For now we are inclined to view the July inflation surprise as reflecting more noise than signal, hence we downplay its significance for policy. But there is probably some truth in both interpretations. The core inflation data is a key variable to watch over the coming months regarding MPC voting behavior…We think the July data are unlikely to prompt any change in voting intentions. But if core inflation sustains its move up and runs comfortably above 1% in the coming months, this could prompt more dissents before the end of the year.

In the very near term, headline inflation is likely to fall in the next release and could turn negative again in 3Q – owing to a combination of falling oil prices, a stronger currency and food prices which showed a surprise decline in July (not all of which will have been captured in the BoE’s August inflation report forecasts). So although July inflation has come in higher than the BoE expected (0.0%oya) due to core inflation surprising on the upside, greater drags from food and energy in the coming months could see headline inflation in 3Q undershoot the BoE’s forecast.

Economists at Barclays:

The acceleration in core inflation will likely attract most attention within the release. We see risks that this may reverse in August, as clothing prices rebounded sharply in that month in 2014 and are unlikely to have rebounded as strongly this year. Likewise, air fares feature in the UK core aggregate and are volatile. Within core inflation, we see Recreation and Culture as worth watching as a bellwether of UK consumer confidence. We do not think that the July inflation data will significantly shift the MPC narrative in the near term.

Philip Shaw, Chief Economist, Investec:

We would argue that today’s figures tell us little about the timing of the first increase in interest rates, which will depend on bigger picture news on domestic growth, pay trends and perceived downside risks in the global economy.

Melanie Baker, Economist, Morgan Stanley:

The outcome was a touch above consensus expectations, though in line with our own. Most of the rise was attributable to (base effects in) clothing (the component partly responsible for last month’s fall in inflation). Looking across the components, with a mixture of upward and downward movements, there was no clear message in our view. Core inflation rose sharply, up 4-tenths to 1.2%. However, much of this will reflect the base effects in clothing and miscellaneous services as well as a rise in the volatile air fares component. Our main core services inflation measures were little changed. We expect inflation to be between 0.0%Y and +0.2%Y for another few months yet, before rising more sustainably. Our forecasts for annual CPI inflation are unchanged after today’s data.

Simon Wells, UK economist at HSBC, probably sums it up best this way:

The MPC’s August Inflation Report showed some evidence of a pick-up in domestically generated inflation recently (partly reflecting rising wages) but little sign of any rise in a range of core inflation measures. Today’s data potentially changes that and will be closely scrutinised by the MPC. If sustained, increased evidence of rising underlying inflation could tip the balance for more MPC members to join Ian McCafferty in voting for a rate rise.

Despite today’s upside surprise, there is no doubt inflation remains very low. Goods price inflation remained negative (-1.8% yoy), as did producer price inflation, thanks to the global oil price. Even services inflation, which rose 0.2pp to 2.4% yoy in July, remains reasonably contained.

While the MPC felt able to ease policy when inflation was around 5% in 2011, keeping interest rates down when inflation is above target is an easier sell to homeowners and borrowers than increasing them when inflation is so low. With a 2% target for CPI inflation, the MPC will have to communicate carefully to borrowers if it chooses to raise rates for the first time since 2007 in such a low inflation environment.

When there are so many disparate views, “tells us little” usually carries the day. The increased focus on core inflation does not yet mean we have more inflation. That means no change to the view rates are set to rise in the first quarter of 2016 but possibly even later. 

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