AXA IM's David Page - Sterling weakens on UK inflation data

David Page, Senior Economist at AXA Investment Managers (AXA IM), comments on today’s UK inflation rate figures:


  • UK CPI inflation stayed at 2.4% in May, this was in line with consensus and remained the slowest price growth since March 2017.
  • Fuel and Easter-travel price increases were offset by energy and recreation base effects and softer clothing and furniture prices in May.
  • Over the next couple of months, combined fuel and utility tariff increases are likely to lift inflation back to around 2.6%, before resuming a disinflationary path over the rest of the year.
  • A rebound in inflation would add to calls for the BoE to tighten policy, but the timing of that outlook has been questioned by recent soft output data.
  • For now, we maintain our outlook for a +0.25% Bank Rate hike in August.

Consumer prices rose by 2.4% on the year to May, unchanged on April’s reading. This was in line with consensus estimates and modestly softer than our own forecast for a marginal acceleration to 2.5%. Inflation remains at its joint lowest level since March 2017. This month fuel prices rose sharply, petrol and diesel up around 4½p/litre on the month, and rising airfares delivered an increase in transport services (+2.1% versus -2.5% last year), reflecting the shifting timing of Easter. However, these inflationary impulses, which together would have added 0.35ppt to headline inflation, were offset by base effects reflecting broadly stable utility and recreation prices, which compared with sharp increase in May 2017, which we had anticipated, and softer clothing and furniture price increases this year, which we had not.

Over the coming months UK inflation looks set to increase as energy costs continue to rise. This should reflect ongoing oil price gains feeding into petrol and diesel prices – particularly next month, and the slightly later than expected rise in utility prices reflecting longer-term increases in sterling-energy costs. Together we forecast these changes to add a further 0.3ppt to headline inflation. These increases are unlikely to be offset in the same manner as this month. Although high street pressures are likely to persist, we suspect May’s soft price increases will result in a more muted summer sales period this year. Beyond, other erratic variations, remaining offset will occur from the fading of the sterling-depreciation impact on prices. On balance, we expect inflation to rise back to 2.6% over the coming months. However, after July we expect inflation to resume a gentle downward path towards 2.25% by year-end.

RPI inflation dipped to 3.3% from 3.4% in April, modestly softer than expected (consensus and AXA IM 3.4% y/y). For us, this was consistent with our assessment of the difference between RPI and CPI (the modest forecast miss reflecting softer CPI inflation) with housing costs contributing less to RPI inflation than the previous month. This differential looks set to be constant in June and July and accordingly we forecast RPI inflation rising back to 3.5% over the coming months.

Our inflation outlook is modestly firmer than the BoE forecast for 2.4% inflation in Q2 and Q3. In broad terms this would have little impact on the outlook for monetary policy, with the MPC unlikely to be unduly motivated by expected short-term, energy driven fluctuations in inflation. Indeed, the August Inflation Report is likely to be more influenced by the around 2% depreciation in trade-weighted sterling since the last report. However, at the margin it would add some argument to tighter policy, reflecting MPC member Ramsden’s comments that inflation was unlikely to return to the 2% target without modest tightening. However, the timing of any such increase has been thrown into doubt following a sharp drop in manufacturing output (and weak rebound in construction) in April. On the face of it, these will make it a challenge to achieve a 0.4% rise in Q2 GDP, consistent with the BoE’s May outlook. Given more forward-looking survey evidence, we expect to see a firmer tone over the coming months and for now maintain our outlook  for an August hike. But our conviction for such a move has softened and further growth disappointments could see this timetable slip further.

Financial markets saw little reaction to this in-line inflation print. After sharp initial gains, bond prices were broadly unchanged on the news, 2 –year and 10-year yields both back to 0.74% and 1.38% as before the release. Sterling has seen some movement, but broadly stable to the US dollar and down around 0.2% to the euro, this appeared to be more a reaction to broader euro strength on the day. Sterling’s softening helped equities gain with the FTSE 100 up 0.6% after the inflation release. Overnight interest swaps still suggest a broadly 50/50 outlook for the next +0.25% hike in August.    

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