UK consumer price inflation rose to 0.5% in June from 0.3% in May, thereby matching June's highest level since December 2014. Inflation looks set to be lifted over the coming months by sterling's marked overall drop following the vote to leave the European Union.
IHS Markit perspective | |
Significance | Consumer price inflation rose to 0.5% in June from 0.3% in both May and April, thereby matching March's highest level since December 2014. Inflation was lifted in June by higher air fares and increased petrol prices. Additionally, core inflation rose to 1.4% in June from 1.2% in May. |
Implications | June marked the 30th successive month that consumer price inflation has been below the Bank of England's 2.0% target rate, but the months of sub-target inflation may well be numbered. |
Outlook | While June's rise in consumer price inflation had little to do with the pound's sharp fall since the vote for Brexit, sterling weakness does look set to increasingly feed through over the coming months to markedly push inflation higher as it raises prices for imported goods and services, oil, and commodities. We suspect that the pound is headed for further weakness despite its recent stabilisation. Consequently, IHS expects consumer price inflation to end-2016 of around 1.5% and to reach a peak just above 3% in late-2017. |
The Office for National Statistics ONS) reported that consumer price inflation moved up to 0.5% in June from 0.3% in both May and April, thereby matching March's highest level since December 2014. Significantly though, the spike in inflation to 0.5% in March (from 0.3% in February) followed by the dip back to 0.3% in April was primarily due to the earlier Easter in 2016 compared with 2015. In particular, this caused airfares to rise markedly in March in 2016 rather than in April, as had been the case in 2015.
Consumer price inflation has so far picked up only gradually overall from 0.1% in November and marginal deflation of 0.1% in both October and September 2015. The United Kingdom had also experienced a 0.1% year on year (y/y) dip in consumer prices in April 2015, which was the first time instance of deflation since the consumer price index (CPI) series started in 1989. Furthermore, the ONS indicated that April 2015 represented the first deflation since 1960, based on comparable historic estimates. In fact, consumer price inflation was locked in a very narrow -0.1 to 0.1% band from February 2015 through to November. This meant that consumer price inflation was 0.0% over 2015, which was down from 1.5% in 2014, 2.6% in 2013, and 4.5% in 2015.
June was the 30th successive month that consumer price inflation had been below the Bank of England's target rate of 2.0%. It also meant that consumer price inflation remained more than one percentage point below the target rate. This has necessitated Bank of England Governor Mark Carney writing six open letters to the Chancellor of the Exchequer (between February 2015 and May 2016) 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 has to do this every three months that inflation remains more than one percentage point below the target rate).
Higher air fares and petrol prices lifted inflation in June
There was an upward impact on inflation in June from higher motor fuel prices as a result of oil prices reaching 2016 highs during the month. Petrol and diesel prices rose by 2.3 pence/litre and 2.6 pence/litre respectively in June, which was larger than the monthly increase seen in June 2015. Additionally, there was a marked rise in airfares in June.
Core inflation up in June
Core consumer price inflation (which excludes food, drink, tobacco, and petroleum) rose to 1.4% in June from 1.2% in both May and April, although it was still just below the 17-month high of 1.5% seen in March (when it was lifted by the spike in airfares). Core consumer price inflation had been as low as 0.8% in June 2015.
UK inflation (% change) | ||||||
M/M | Y/Y | |||||
| Jun 16 | Jun 16 | May 16 | Year to date | 2015 | 2016 |
Consumer price inflation, total | 0.2 | 0.5 | 0.3 | 0.3 | 0.0 | 0.1 |
Food and non-alcoholic beverages | -0.4 | -2.9 | -2.8 | -2.6 | -2.6 | -2.0 |
Housing, water and fuels | 0.2 | 0.1 | 0.0 | 0.2 | 0.5 | 0.0 |
Transport | 1.1 | -0.2 | -1.0 | -0.7 | -2.1 | -1.0 |
Recreation and culture | 0.6 | 0.8 | 0.1 | 0.2 | -0.6 | 0.0 |
Hotels and restaurants | 0.1 | 2.3 | 2.6 | 2.1 | 1.9 | 1.6 |
PPI, manufacturing | 0.2 | -0.4 | -0.6 | -0.8 | 0.1 | 0.4 |
Source: Office for National Statistics | ||||||
There was some upward impact on core inflation in June from recreation and culture mainly in the form of higher prices for toys and hobbies (mainly computer games) while communication costs rose 0.6% month on month (m/m), which lifted the year on year (y/y) increase to 3.7% from 2.8% in May.
Overall services inflation rose to 2.8% in June from 2.6% in May. Meanwhile, the y/y fall in goods prices narrowed to 1.6% in June from 1.8% in May. However, there was some downward impact on inflation in June from lower prices for furniture and furnishings and for clothing and footwear. Additionally, there were reduced price increases at restaurants and hotels.
Very low inflation has helped consumers
Prolonged negligible consumer price inflation has been of major benefit to consumers by supporting their purchasing power. However, some employers have clearly used prolonged negligible inflation as a reason to limit pay awards, which is less good news for consumers.
At 0.5% in June, consumer price inflation is 1.5 percentage points below annual average earnings growth of 2.0% in the three months to April (the usual benchmark used and the latest available data), thereby indicating still decent consumer purchasing power.
It looks probable that consumer purchasing power will be significantly diluted over the coming months as inflation trends higher and earnings growth is limited. Companies may well look to clamp down on workers' pay as they strive to save costs in a more difficult environment following the UK's vote to leave the European Union and as imported input prices are lifted by the weakened pound. Meanwhile, a likely softening labour market and markedly reduced consumer confidence will dilute workers' ability and willingness to push for higher pay awards
Outlook and implications
Inflation outlook
Following the UK's vote to leave the European Union in the 23 June referendum, the inflation outlook now looks to be significantly higher than before.
Prior to the Brexit vote, consumer price inflation was seen rising gradually to reach 1.0% on the fourth quarter of 2016 and 2.0% in late-2017.
In our July forecast, we see consumer price inflation up around 1.5% at the end of 2016, moving above its 2.0% target during the first quarter of 2017 and reaching a peak around 3.3% in late-2017.
The UK's vote to leave the European Union has seen the pound plunge from around USD1.50 to trade as low as USD1.2798 (a 31-year low). IHS expects the pound to trend significantly lower over the coming months to eventually trade around USD1.20 for a prolonged period. Given that oil and commodity prices are largely quoted in US dollars, this is likely to have a particularly marked upward impact on inflation. Sterling is also seen as weakening appreciably against other currencies, which will push up other imported prices, including for food.
The upside for consumer price inflation will likely be limited by a number of factors. Oil and commodity prices are likely to firm only modestly in US dollar terms, as an already uncertain global growth outlook is reinforced by the wider repercussions of the United Kingdom's vote to leave the European Union.
More fundamentally, the weakened UK growth and employment outlook means that domestic price pressures are likely to be limited. Slack in the economy is likely to widen anew in the near term, while companies will be keen to keep earnings growth down to contain costs. Meanwhile, retailers, manufacturers, and services companies will likely find their pricing power limited, given that the past prolonged squeeze on households' purchasing power has made consumers very price-conscious.
Bank of England likely to cut interest rates in August as part of package
While the Monetary Policy Committee has stressed the importance of keeping an eye on inflation risks following the vote for Brexit, the rise in consumer price inflation to 0.5% in June is unlikely to deter the Bank of England from pressing ahead with monetary policy stimulus in August given serious concerns and uncertainties about the economic situation and outlook.
IHS expects the Bank of England to cut interest rates from 0.50% to 0.25% at its 4 August meeting. We also suspect that the Bank of England will revive quantitative easing in August and the bank could also very well extend its Funding for Lending Scheme. Quantitative easing has been on hold since November 2012 with the stock of purchases at GBP375 billion. It is highly possible that the Bank of England could engage in greater buying of corporate bonds in further quantitative easing, rather than focusing primarily on gilts.
We have serious doubts that the Bank of England will take interest rates any lower than 0.25%, although it is possible it could take them down to 0.10%; and we certainly believe that negative interest rates are highly unlikely. Bank of England Governor Mark Carney certainly seems wary of taking interest rates any lower than 0.25% and appears to be set against negative interest rates. It is notable that when delivering the Bank of England's Financial Stability Report on 5 July, Carney stated that it is "extremely important that any monetary action is well aimed" and "should consider unintended consequences".. This tied in with him commenting in his 30 June speech that "as we have seen elsewhere, if interest rates are too low (or negative), the hit to bank profitability could perversely reduce credit availability or even increase its overall price".