17 Jan 2017

UK CPI (Dec): Some erratic uplifts, but the inflation squeeze is coming...

Philip Shaw

Chief Economist

Today’s official data showed the rate of inflation outstripping expectations. The headline CPI rate for December came in at +1.6% y/y, versus a consensus forecast of +1.4% (Investec +1.3%). That is a sharp rise from the +1.2% y/y rate seen in November and the firmest since July 2014.

The ‘core’ inflation rate (excluding food, energy, alcohol and tobacco) was also +1.6% y/y (consensus and Investec +1.4%). That is +0.2pp higher than in November and the highest rate since August 2014. The RPI numbers were also firm, with RPI inflation at +2.5% (consensus +2.3%, November +2.2%) and RPIX inflation at +2.7% (consensus +2.5%, November +2.5%). We also note that Producer Price (PPI) numbers were published at the same time – there were no big surprises here but we do note that the rate of producer input price inflation has now climbed to +15.8% – the highest since 2011.

The drivers of December’s rise in CPI inflation appear to boil down to four factors:

  • First, there was a sharp increase in ever-volatile air fares. Prices rose by +49% m/m – although that is only a little higher than the 46% increase seen at the same the previous year, this category now has a higher weight in the consumer basket. This effect (which tells us little about underlying inflationary pressure) contributed +0.1pp to the rise in the inflation rate.

  • Second, energy-related ‘base effects’ (ie sharp fuel price declines in December 2015 dropping out of annual calculations) played a role. The ‘fuel and lubricants’ category saw much less pronounced monthly price declines last December than in December 2015, also contributing around +0.1pp to the inflation rate.

  • Third, food price inflation has become much less negative. The annual rate for this category rose to -1.1% in December from -2.0% in November. A chunk of this likely reflects the impact of post-EU referendum declines in sterling.

  • Fourth, underlying inflationary pressures might be building across a range of categories. We note that price rises in sectors ranging from clothing, hotels, cafes, to recreation services, were somewhat more marked than we had anticipated. This might reflect a combination of sterling effects passing through the supply chain. It might also reflect the fact that demand pressures remain firm, given the (surprisingly) robust economic activity that has followed the Brexit vote.

Taken together, these factors suggest that some of the rise in inflation looks erratic (air fares) or ‘one-off’ in nature (energy base effects). But the pass through of higher import prices is beginning to happen. Alongside decent demand conditions (we only anticipate a mild growth slowdown this year), we see CPI inflation rising to almost 3½% towards the end of this year.

Today’s inflation numbers, despite the upside surprise, will have little effect on monetary policy. Last night, BoE Governor Mark Carney said in a speech that the outlook for Bank rate will depend on the trade-off between tolerating higher inflation while guarding against higher unemployment resulting from an economic slowdown as higher prices squeeze household spending power. It will take months to evaluate how that trade-off unfolds. But we do see Brexit related headwinds keeping the MPC hold until at least the end of 2018.

Consistent with that view, sterling only flickered upwards for a few minutes following today’s data. Of course, the main event today will be PM Theresa May’s speech on Brexit, set for 11:45. We will be publishing our take on the speech later today.