Numerous posts here over the last three years predicted that UK inflation would overshoot Bank of England and consensus forecasts. Since the spring, however, it has been suggested that CPI inflation would peak at a lower level and fall faster than generally expected, while remaining above the 2% target over the medium term.
The chart below shows updated profiles for CPI and RPIX inflation taking into account July outturns, which were broadly in line with expectations at the headline level but with some differences within the detail. CPI inflation is forecast to rise from 4.4% in July to a peak of 4.8% in September / October before falling sharply to 2.5% in April 2012.
RPIX inflation may already have peaked at 5.5% in February, though is projected to return to this level in October (from July’s 5.0%), before falling to 3.4% next April.
For comparison, the Bank of England expects CPI inflation to reach a quarterly-average peak of 5.0% in the fourth quarter of 2011, falling to 3.3% in the second quarter of 2012. The latter figure is 0.5 percentage points higher than implied by the forecast here.
The profiles in the chart are based on “core” prices rising at their recent rate (allowing for seasonal movements), with the projected sharp decline in late 2011 / early 2012 mainly driven by the VAT effect and falls in petrol and food inflation in lagged response to recent commodity price stabilisation. The forecasts assume a stable exchange rate – an important proviso.
The prospect of a larger drop over the next 12 months does not, of course, vindicate the MPC’s inaction in the face of the prior surge. On the forecast here, CPI inflation will remain above the 2% target through the end of 2012 and probably beyond. The index, moreover, is currently 5.5% above the level implied if the target had been met since the CPI was adopted as the reference measure in 2003. This overshoot implies a probably-permanent loss of purchasing power for savers who mistakenly based their investment decisions on an assumption that the MPC would fulfil its remit.
