UK Reaction: Inflation falling slowly

• Consumer price index (CPI) inflation eased to 10.1% year-on-year (y/y) in March, down from 10.4% in February, driven by falls in fuel prices but rises in food prices and recreation kept inflation elevated. This reading came above consensus estimates of an easing to 9.8%.

• Core CPI remained at 6.2%, above consensus estimates of the rate easing to 5.8% and with declines in core goods prices offset by further increases in core services on the month.

• We look for a 25 basis point (bp) hike from the Monetary Policy Committee (MPC) in May. Signs of stickiness in core CPI and yesterday’s strong wage data are likely to keep the MPC focused on the risks of inflation persistence. 

CPI inflation declined to 10.1% y/y in March, down from 10.4% in February, as falls in fuel prices drove the decline. This reading came 30bp above consensus estimates of inflation easing to 9.8% and comes 90bp above the Bank of England's (BoE) projections published back in February. Core CPI inflation remained at 6.2%, above consensus estimates of an easing to 6.0%. Retail Price Index (RPI) inflation fell to 13.5% (compared to expectations of a decline to 13.3%) whilst Retail Price Index excluding mortgage interest payments (RPIX) fell to 12.6%.

The decline in inflation was driven by an easing in fuel prices which was offset by prices of food and recreation and culture which continue to rise. Of the 0.3 percentage point (ppt) decline in CPI between March and February, declines in petrol and diesel prices which fell by 5.9% y/y contributed -0.3ppt. Declines in energy as the price of heating oil fell sharply also contributed (-0.1ppt). These declines were offset by price increases in food and recreation and culture goods and services. Inflation also eased in restaurants and hotels by less than we were anticipating. Food prices continue to rise, picking up 1.1% on the month and now stands at 19% – Office for National Statistics modelling indicated food inflation now stands at the highest rate since August 1977. Interestingly, despite widespread shortages in fresh products that were seen in March the recent pickup appears to be driven by processed food.

Both core and services CPI which most closely reflect domestic inflationary pressures and are closely watched by the MPC remained elevated; services CPI remained at 6.6% and core CPI remained at 6.2%.

Inflation continues to fall, but not as fast as we, or the BoE had been expecting, with inflation remaining above double-digits for seven consecutive months – a development that will continue to unsettle the MPC and add to worries of inflation persistence. Rises in food prices are keeping headline elevated, but cannot explain all of the upside surprise as price pressures remain broad-based. We expect CPI to fall sharply in April as increases in fuel and household energy prices seen last year drop out of the headline. However, whilst the labour market remains tight, we continue to see risks to inflation as firmly skewed to the upside.

This print strengthens our expectations that the MPC will hike by 25bp at its next meeting in May. The continued strength of core and services inflation alongside yesterday’s unexpected increase in private sector wages will keep the MPC focused on the risk of further persistence in inflation. At the moment we expect the MPC to pause their hiking cycle at 4.50%, pencilling in cuts to Bank Rate beginning in Q4 2022 with 25bp cuts each quarter out to end 2024 bringing Bank rate to 3.25%.

Markets reacted to the upside surprise in inflation, repricing their expectations for rate hikes from the BoE. Markets now have priced a 25bp hike from the BoE with 95% probability compared to 80% on Tuesday. The pound also rose against the dollar following the release of the data, rising by 0.4% to $1.246.