UK consumer prices edged up 0.1% year on year in November, after drops of 0.1% in both October and September. Reduced falls in fuel prices helped to push up inflation in November while core inflation climbed to 1.2% from 1.1% in October.
IHS perspective | |
Significance | UK consumer price inflation returned to marginal positive territory of 0.1% in November, after 0.1% year-on-year dips in both October and September. Nevertheless, consumer price inflation was still in the -0.1% to +0.1% range that has held since February. |
Implications | The United Kingdom has really only ever been in deflation technically as well as marginally. The y/y drop in prices has been far from generalised and driven by falling fuel and food prices. It has never seemed likely that consumers would be tempted to start delaying purchases in anticipation of falling prices. Indeed, prolonged essentially flat consumer prices have benefited consumers by boosting their purchasing power. |
Outlook | Consumer prices will likely now trend gradually upwards, although much will clearly depend on oil prices, which have hit a seven-year low. The current weakness in oil prices means that renewed year-on-year falls in consumer prices cannot be ruled out and it has increased the likelihood that consumer price inflation will remain extremely low for longer. |
The Office for National Statistics ONS) reported that the United Kingdom returned to marginal positive consumer price inflation in November after two months of mild deflation. Specifically, consumer prices rose 0.1% year on year (y/y) in November, after a dip of 0.1% y/y in both October and September. Consumer prices had previously been flat y/y in August and up 0.1% y/y in July.
The United Kingdom had earlier experienced marginal deflation in April when prices also fell 0.1%, which was the first instance of deflation since the consumer price index (CPI) series started in 1989. Furthermore, the ONS indicated that April posted the first deflation since 1960, based on comparable historic estimates.
In fact, consumer price inflation has been locked in a very narrow -0.1 to 0.1% band since February. Annual consumer price inflation had come down to 0.0% in February from 0.3% in January, 0.5% in December 2014, 2.0% in December 2013, and a 14-month high of 2.9% in June 2013
At 0.1% in November, consumer price inflation was again more than one percentage point below the Bank of England's target rate of 2.0%. This has already necessitated Bank of England Governor Mark Carney writing four open letters to Chancellor George Osborne (in February, May, August, and November) explaining why consumer price inflation has moved more than one percentage point below its target rate of 2.0% and what the Bank of England proposes to do about it. Carney looks likely to have to write more letters to the Chancellor over the coming months (he needs to do so every three months that inflation remains more than one percentage point below the target rate).
Furthermore, November was the 23rd successive month of sub-target inflation. In marked contrast, consumer price inflation stayed above the 2.0% target level continuously between December 2009 and November 2013. Indeed, consumer price inflation exceeded the 2.0% target rate by more than the one-percentage-point permitted band from March 2010 through to March 2012.
Consumer price inflation was first brought down to -0.1% in April by a combination of factors, notably including food price disinflation and then deflation (heightened by a supermarket price war) and reduced transportation costs (reflecting markedly lower petrol prices as oil prices plunged to a near-six-year low in January). A strong pound has also helped limit inflation, while all the major utility companies cut their gas and electricity prices in the early months of 2015.
The country's exit from deflation in May was largely due to a rise in petrol prices during the month and a rebound in air/sea transport prices and some holiday prices after April's dip. UK inflation has since continued to hover around zero primarily due to still weakened oil and food prices.
Inflation lifted in November by reduced fall in transport prices
The UK's return to marginally positive consumer price inflation in November was significantly due to petrol and diesel prices falling less this year than they did in November 2014. Specifically, petrol prices fell 1.5p/litre in November 2015 compared with a drop of 3.0p/litre in November 2014, while the fall in diesel prices was limited to 0.6p/litre compared with 2.9p/litre. The ONS also reported that the prices of second-hand cars rose 1.6% m/m this November compared with a fall of 1.0% m/m a year ago. Consequently, the y/y drop in transport prices narrowed to 2.1% in November from 2.6% in October.
There was also upward pressure on inflation in November from food and non-alcoholic beverage prices edging up 0.1% month on month (m/m), causing the y/y drop to narrow to 2.4% from 2.7% in October. Additionally, higher prices for spirits and wine caused the y/y increase in alcoholic beverages and tobacco to rise to 1.4% in November from 0.3% in October.
UK inflation (% change) | ||||||
| M/M | Y/Y | ||||
| Nov 15 | Nov 15 | Oct 15 | Year to date | 2013 | 2014 |
Consumer price inflation, total | 0.0 | 0.1 | -0.1 | 0.0 | 2.6 | 1.5 |
Food and non-alcoholic beverages | 0.1 | -2.4 | -2.7 | -2.6 | 3.8 | -0.2 |
Housing, water, and fuels | 0.1 | 0.3 | 0.2 | 0.5 | 4.1 | 3.0 |
Transport | -0.7 | -2.1 | -2.6 | -2.3 | 1.0 | 0.3 |
Recreation and culture | 0.0 | 0.1 | -0.4 | -0.6 | 1.1 | 0.9 |
Hotels and restaurants | 0.2 | 1.8 | 1.6 | 1.9 | 2.7 | 2.4 |
PPI, manufacturing | -0.2 | -1.5 | -1.4 | -1.7 | 0.8 | 0.9 |
Source: Office for National Statistics | ||||||
Meanwhile, core inflation (which excludes energy, food, alcohol, and tobacco) edged up to 1.2% in November from 1.1% in October and 1.0% in both September and August. It had been as low as 0.8% in June.
A significant upward impact in November came from miscellaneous goods and services, for which prices rose 0.3% m/m causing the y/y increase to climb to 1.3%, up from 0.8% in October. Within this, car insurance premiums increased markedly. Overall, services inflation rose to 2.4% in November, up from 2.2% in October. Meanwhile, the y/y drop in goods prices narrowed to 1.9% from 2.4%. This was despite clothing and footwear prices unusually edging down m/m in November, causing them to be flat y/y after an increase of 0.8% y/y in October.
Deflation/low inflation helps consumers
The United Kingdom has really only ever been in deflation technically as well as marginally. The y/y fall in consumer prices has been far from generalised and has been driven by falling fuel and food prices. It has never seemed likely that consumers will be tempted to start delaying purchases in anticipation of falling prices. Significantly, latest surveys of households' inflation expectations have been stable and clearly in positive territory. Furthermore, given the current strength of the economy and relatively tight labour market, there has been little risk of any damaging deflationary spiral taking hold.
Indeed, deflation/negligible inflation has been of major benefit to consumers through boosting their purchasing power. Inflation of 0.1% in November is 2.9 percentage points below annual earnings growth of 3.0% in the three months to September (the three-month measures is the usual earnings yardstick used and the latest available data is for September). While earnings growth actually dipped to 2.0% in September itself, this is still 1.9 percentage points above inflation.
Outlook and implications
Consumer prices will likely trend gradually upwards from now on, although much will clearly depend on what happens with oil prices, which have hit a seven-year low in mid-December. The current weakness in oil prices means that renewed y/y falls in consumer prices cannot be ruled out and it has increased the likelihood that consumer price inflation will remain extremely low for longer.
Gradually rising inflation should be the consequence of base effects becoming less favourable (oil prices fell particularly sharply in late-2014/early-2015), higher earnings growth, and diminishing excess capacity in the economy.
Nevertheless, consumer price inflation will probably only reach 1.0% in the third quarter of 2016, 1.5% by end-2016, and 2.0% around mid-2017. Brent oil prices hit a seven-year low of USD36.33/barrel in mid-December; and IHS expects oil prices to be muted for a prolonged period to average USD54.5/barrel in 2016 and USD65.5/barrel in 2017. In addition, commodity prices have recently been very weak and are likely to remain soft.
Underlying price pressures will likely firm only gradually. While GDP growth is expected to hold up pretty well over the coming quarters, this situation should lead to only a relatively gentle pickup in underlying inflationary pressures. Although earnings growth has trended up and should continue to rise, it is unlikely to race ahead (indeed, earnings growth suffered a relapse in September). Furthermore, an expected further improvement in productivity (which picked up appreciably in the second quarter) should limit the inflationary impact of rising earnings.
Meanwhile, retailers, manufacturers, and services companies will likely find their pricing power limited for some time to come, given that the past prolonged squeeze on households' purchasing power has made consumers much more price conscious. Indeed, supermarkets remain heavily engaged in a food price war. Furthermore, a strong pound (it hit a seven-and-a-half-year trade-weighted high in August and is still relatively elevated) is limiting inflationary pressures. Inflationary pressures are very weak in the United Kingdom's trading partners as well, which should restrain import prices.
Bank of England still likely to raise interest rates by mid-2016
With consumer price inflation still only 0.1% in November, there is little immediate pressure on the Bank of England to start raising interest rates. While the Monetary Policy Committee (MPC) will note that core inflation edged up to 1.2% in November from 1.1% in October and 1.0% in September, this is still well below the level the Bank of England wants. Further reason for Bank of England caution on interest rates is the slowdown in UK GDP growth in the third quarter and signs that the recent growth in earnings has levelled off, at least temporarily.
IHS maintains the view that the Bank of England is more likely than not to raise interest rates by mid-2016 (we expect a move in May). We suspect that decent UK economic growth, a renewed pickup in earnings growth, and consumer price inflation gradually trending up will prompt the MPC to act around May
However, we doubt interest rates will end 2016 any higher than 1.0% – and it is far from inconceivable that the Bank of England may only raise interest rates once to 0.75% during the year. The Bank of England will likely wait for a while following the first hike to see how the economy reacts to an interest rate hike, given that the rate has been down at 0.50% since March 2009. The fact that interest rates have been so low for so long means that even a small rise could significantly affect consumer (especially) and business psychology and behaviour. It is also very possible that the economy may be hampered by increased uncertainty ahead of the referendum on EU membership, which could well occur in the second half of 2016.
Further out, we see the Bank of England only lifting interest rates to 1.75% by end-2017 and 2.25% by end-2018. The Bank of England has repeatedly stated that when interest rates do start to rise, the increases will likely be both gradual and limited – although it stressed this guidance is an expectation not a promise.