AXA IM's David Page - UK reaction: Downside CPI inflation surprise adds to policy inertia
David Page, Senior Economist at AXA Investment Managers (AXA IM) retains outlook that CPI inflation should peak in Q4 2017, but now questions if this will be above 3.25% as Theresa May suggested.
- UK CPI inflation softened to 2.6% in June from 2.9%. Food prices, transport services costs and recreation contributed to the softer reading.
- Producer price inflation softened in input and output terms, although ‘core’ output price inflation edged higher.
- We retain our outlook that CPI inflation should peak in Q4 2017, but now question if this will be above 3.25% as May’s release suggested.
- A modest softening in the inflation outlook, reduces the case for a short term adjustment in UK monetary policy.
- We retain our outlook that, on balance, the Bank Rate will remain unchanged into 2019.
“UK inflation surprised in June. Consumer Price Index (CPI) inflation was softer than expected at 2.6% (AXA IM and consensus 2.9%). CPI ‘core’ inflation was also weaker at 2.4% (consensus 2.6%). June’s surprise was driven by two main developments:
1. Food prices fell in June, reflecting declines in both seasonal and non-seasonal food. The softness of food price inflation defied some indicators of global food price inflation. It raises a question as to whether domestic supermarket competition, particularly in the light of pressures on household budgets, may be cushioning the sterling-related upward impulse to consumer food prices.
2. Transport services inflation was also milder than expected. While transport services rose by 1.8% on the month, this defied our expectation for a sharper pick-up, driven by airfares, which rose by 14.5% on the month. The relative softness reflected price falls in ‘other’ and rail components of services.
“Otherwise, we note that recreation prices retreated in June, after a strong rise in May. However, clothing, furniture and communication prices were not as subdued as we had expected in June.
“June’s producer price inflation figures were released alongside consumer price inflation. These presented a mixed picture, with input prices falling to 9.9% from an upward revised 12.1% in May (from 11.6%) – a slowdown consistent with consensus, but from a slightly faster starting point. Factory gate inflation slowed to 3.3% from 3.6%, but ‘core’ producer output prices inched higher to 2.9% from 2.8% against expectations for stability. We note the historic close (leading) relationship between producer output prices and consumer price inflation, which suggests that CPI inflation may be closer to a peak than previously considered.
Source: National Statistics
“The outlook for inflation remains uncertain. The sharp rise in inflation in May suggested a faster (and possibly stronger) pass through of sterling depreciation to consumer prices than in previous episodes. Accordingly we had increased our estimate of peak UK inflation (which we consider likely in Q4 2017) to above 3.25%, from modestly below. However, with the reversal of some of May’s evidence, particularly in the large recreational prices component, and with evidence suggestive of competitive pressures mounting in food retailing, we wonder if such a revision was premature?
“Today’s inflation will alleviate some of the Monetary Policy Committee’s (MPC) recent angst. A softer headline rate reduces the urgency for any shift in policy and adds to our conviction that policy will remain unchanged in August. More fundamentally, evidence that inflation may not peak far in excess of the MPC’s outlook and that domestically generated inflation pressures (for example services inflation, which slowed to 2.7% from 3.0% in April) should reduce concerns that UK policy is currently overly stimulative. Financial markets appear to have drawn to similar conclusions. 2-year and 10-year gilt yields eased back 4 basis points (bps) to 0.27% and 1.24% respectively (with sterling softer and equities ‘firmer’). The probability of a rate hike, implied by OIS rates (overnight index swaps) retraced to 43% after today’s release, from close to 50% before. We retain our outlook that not only will the MPC leave policy unchanged in 2017, but that successive downside surprises to growth, the Brexit process and the political background are likely to see the MPC maintain the same cautionary stimulative policy across 2018 and into 2019.”
Jayne Adair +44 20 7003 2232 - Jayne.Adair@axa-im.com
Tuulike Tuulas +44 20 7003 2233 - Tuulike.Tuulas@axa-im.com
Amy Butler +44 20 7003 2231 - Amy.Butler@axa-im.com
Jess Allum +44 207 003 2206 – Jessica.Allum@axa-im.com
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