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Inflation figures – Groundhog Day?

Ben Brettell

Today’s inflation bulletin from the ONS feels somewhat like Groundhog Day, as the fall in sterling continues to make its way through to the high street. From Ben Brettell, Senior Economist, Hargreaves Lansdown.

Consumer price inflation rose to a three and a half year high of 2.3 percent in February, up from 1.8 percent in January and above the Bank of England’s 2 percent target for the first time since November 2013. The figure exceeded consensus forecasts of 2.1 percent, but despite this the market reaction was relatively muted, with sterling gaining around a third of a cent and the FTSE trading a few points lower. As has been the case since last summer, the main culprit was the rising cost of transport, driven by higher fuel prices. Oil is priced in dollars, and sterling has fallen around 13 percent on a trade-weighted basis since last June’s referendum. As such transport costs accounted for 0.8 percentage points of the overall figure.

Bank of England policymakers predict inflation will peak at 2.8 percent in the first half of next year, before a gradual fall back towards the 2 percent target. Many economists forecast a much higher peak, with respected think-tank NIESR saying inflation will reach 3.7 percent. But despite elevated inflation, those hoping for higher interest rates are likely to be in for a long wait. The most recent Bank of England minutes note that to attempt to offset the effect of weaker sterling on inflation would come at a cost of higher unemployment. As such I expect the Bank to look through these higher numbers and keep bank rate at 0.25 percent for the remainder of this year.

Meanwhile inflation at 2.3 percent is now higher than the growth in average earnings (2.2 percent), meaning real pay is officially shrinking. The interplay between these two numbers will be closely watched over the coming months. The UK economy relies heavily on consumer spending and a squeeze on household budgets would not be good news. As for the next few months’ inflation bulletins – expect more of the same. Note: a change to the headline measure, but CPI still the number to focus on.

CPI doesn’t take into account housing costs, so in an attempt to rectify this, the ONS will now use CPIH as their headline measure. As a proxy for owner-occupier housing costs, it includes council tax, plus a measure of how much a home-owner would pay to rent their home. Whether or not this is a good proxy is open to debate. The UK Statistics Authority, which regulates the ONS, still isn’t happy with the way owner-occupier costs are calculated, making CPIH a somewhat controversial number at present. For now I expect economists, the markets and the media to continue using CPI as their key measure of inflation, not least because the Bank of England will continue to target it.

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