UK inflation: stubborn "core" pressures at odds with consensus optimism
Simon Ward
1 Comment
UK consumer price inflation fell to an annual 4.2% in December as energy and food prices slowed and the effects of last year’s VAT hike started to drop out of the comparison. A sharp decline in late 2011 had been widely predicted so today's news does not represent a favourable surprise. (A 4.2% end-year headline rate was forecast here in the summer.)
The December CPI print was above 2% for the sixth consecutive year.
The Bank of England’s claim that CPI inflation will fall dramatically during 2012, finishing the year below target, has, like its earlier optimistic forecasts, been accepted by the consensus – the average projection for the first quarter of 2013 is 1.9%, according to Consensus Economics. Such a plunge, however, requires a significant decline in “core” price momentum and / or further weakness in global commodity prices – both doubtful.
The first chart below shows one measure of core prices – the CPI excluding unprocessed food and energy incorporating an attempt to strip out recent VAT effects and adjusted for seasonal factors. The 12-month increase in this measure rose to 2.6% in December, the highest since January 2010. Six-month momentum of smoothed prices was slightly lower at 2.5%, having been stable during the second half of 2011, showing no response to economic weakness.
The six-month momentum measure has remained at or above 2% since January 2008. It failed to rachet lower in the wake of the “great recession” so is unlikely to drop suddenly now.
If core inflation remains resilient, forecasts of a sub-2% headline rate will depend on a big drag from food and energy prices. Food should have a favourable impact but energy and other industrial commodities tend to correlate with emerging-world economic activity, which is now reviving. The second chart shows the six-month change in the Journal of Commerce industrial commodity price index together with a leading indicator for the “E7” emerging economies. The leading indicator has recovered to a level historically consistent with rising raw material costs.
The third chart shows an inflation forecast based on stability in core price momentum and energy prices coupled with a fall in unprocessed food price inflation to 1% by mid-2012. It also incorporates a 0.2 percentage point upward impact from university tuition fees from October. Headline CPI inflation is projected to finish 2012 at 2.6% after reaching an interim low of 2.4% in August.
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Reader Comments (1)
Why the BOE forecast keeps being accepted I do not know. I can only assume it suits the bankers to pass this on to their clients as it helps obscure the fact that many investments are delivering below-inflation returns.
In 20 years or so I can foresee Dr King telling us that he had to sacrifice his personal integrity and constantly predict lower inflation than was likely in order to keep the bond markets happy, for the country.
When the BOE is buying government bonds at below inflation returns with printed money then of course this will stoke more inflation, it is putting more money in than it is taking out with the excess finding its way into government spending and thus into the pockets of government workers, pensioners etc.