UK Inflation Leaves Some Economists Eyeing a BoE Rate Cut in 2020, as Others Tip a Rate Hike

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- UK consumer price index dips lower but core inflation steadies.

- CPI dropped to 1.5% last month but the core rate held at 1.7%.

- Capital Economics sees BoE cutting on weak CPI, slower growth.

- But Pantheon says window for rate cut has passed, inflation to rise.

Inflation figures for the month of October highlighted benign consumer price pressures on Wednesday and led some economists to warn of an interest rate cut from the Bank of England (BoE) in the first half of 2020, although others say the bank's window for a reduction in borrowing costs has already passed.

The UK consumer price index fell to 1.5% in October, from 1.7% previously, when markets had looked for a decline to only 1.6%. But core inflation, which is seen as a more reliable indicator of domestically generated inflation pressures, held steady at 1.7%. Both numbers are below the BoE inflation target of 2%.

Core inflation, which eliminates volatile energy items from the consumer goods basket as well products which have regulated prices (tobacco and alcohol) that can distort underlying trends in organic inflation, has been below the 2% target since August 2018 when the BoE lifted Bank Rate to 0.75%. The main inflation rate has frequently been reported at or above 2% owing mainly to volatility in the oil market, which impacts energy prices.

"October’s consumer price inflation figures were in line with the Bank of England’s expectations so they are unlikely to move the dial on the outlook for interest rates," says Ruth Gregory at Capital Economics. "The figures do little to change our view that inflation will spend more time below 2% than above it in 2020 and that if Brexit is delayed further, interest rates will be cut, in May 2020."

Markets care about inflation statistics because central banks are obliged to use interest rate policy to keep price growth contained within preset parameters. The BoE's target is to ensure the consumer price index averages 2% over the medium-term, but inflation is sensitive to growth which means the pulse of the economy is important to the outlook for both prices as well as rates. 

The UK economy has slowed further this year and the third-quarter rebound from a surprise contraction in the prior period was weaker than many economists had foretold, with political uncertainty over the Brexit pathway and future trade arrangements firmly in the frame for the slowdown. Capital Economics says the uncertainty thrown up by repeated delays to the UK's exit from the EU has damaged the economy and that further dithering on the path ahead will simply beget even slower growth.

The London-based consultancy forecasts that a further Brexit delay would likely force the BoE into a rate cut because the economy would be likely to remain stuck in a low gear and price pressures might wane further. However, others say the Bank of England's window for a rate cut has now passed and that inflation should rise next year as growing worker wage packets and increased government spending lead to 'excess demand' in the economy. 

"Looking ahead, CPI inflation looks set to hover about 1.5% over the next six months," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "But in the second half of 2020, rising core inflation should help to push the headline rate back to 2% target. The MPC’s policy actions always are informed by its assessment of the medium-term outlook for inflation...Accordingly, we still doubt that the relatively subdued near-term outlook for inflation will steer the MPC to cut Bank Rate soon."

Tombs has been rated by Bloomberg and Reuters as the UK's number one inflation forecaster and he projects that lower energy prices, an April 2020 reduction of water bills and a freeze of duties on alcohol and tobacco will mean the headline consumer price index remains below the 2% target for at least the next six months. But beyond that period, rising services inflation and increased wage packets will fuel a steeper rise in the core consumer price index. 

Two out of nine BoE policymakers voted last week for an immediate cut in Bank Rate to 0.5% but Tombs has told clients the the 'dovish' bias demonstrated by the dissenters on the Monetary Policy Committee will not be maintained through next year. He's forecasting the BoE will "lean against the wind" and raise its interest rate to 1% in the second half of next year. 

"The MPC's forecasts take no account of the fiscal stimulus that likely will be implemented next year, whichever party wins the next election," Tombs says. "Both the Conservative and Labour parties already have announced ambitious plans for infrastructure spending. Public sector investment looks set to rise to about 3.0% of GDP in 2024/25 under the Tories and to 3.6% under Labour, from 2.1% currently. Accordingly, we continue to think that the MPC will need to lean against the wind and raise Bank Rate in the second half of next year."

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