Slow and Steady Wins the Race – The Q1 May 2015 Inflation Report

Released this month, the 2015 Q1 inflation report has assured businesses that economic recovery will continue despite perceived weaknesses earlier this year.

2014 saw GDP growing above the historic average, levelling out in the second half of the year. In comparison, Q1 of 2015 saw CPI inflation at 0.0%, raising concerns over GDP Growth and whether it would be returning to levels seen in 2014 any time soon.

Despite worries, the Bank of England have made assurances that growth remains solid and that the 2% target will return by 2017, once food and energy prices stop falling and wages begin to rise again.

It cannot go un-noted that wage growth remained subdued in Q1, despite a fall in unemployment levels. This was primarily due to lower-skilled jobs having the highest rate of employment, which tend to be lower paid. However, the Bank of England have predicted that employees and firms are expecting a little recovery in pay growth over the coming year as domestic demand picks up the slack of low prices.

Low energy and food prices have indeed been fuelling demand-led growth in the domestic sphere. With more people now in employment, household income is rising along with real income, therefore increasing spending power. Household consumption growth is expected to remain solid throughout 2015, which is good news for retail.

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Confidence in the domestic sector has increased and consumption has risen by 3/4 in Q1. There has been a robust growth in retail sales volumes, but one must remain cautious that it is still too early to predict how much this has to do with lower prices.

Supply side growth is also improving as business investment continues, supporting an increase in productivity. Now the political situation is stable, there is less domestic uncertainty. Supportive financial conditions are also continuing, namely low interest rates and low yields on corporate bonds, which continues to increase the attractiveness of capital spending.

Productivity has remained sluggish but as the composition of the workforce continues to change and unemployment continues to fall, the MPC’s judgement is that productivity will increase over time and in turn boost the supply capacity of the economy.

Nevertheless, despite the positive outlook, the concern remains that inflation is at 0.0%, well below the MPC’s 2% target, despite the rise in demand and continued business investment.

Falling energy prices, reduced global agricultural prices and the appreciation of sterling have all been factors in dragging down the UK’s annual inflation rate and this is a situation which will take time to remedy. The path of inflation is expected to continually depend more on domestic cost pressures meaning that as long as oil and food prices are low, inflation will continue to fall short of the 2% target.

Overall, the outlook appears to be positive for economic growth despite low inflation and wages not rising as much as employment rates would lead us to assume. The majority of uncertainty will now come from global developments and whether or not we will see oil prices rises again.