UK Inflation Dips in February but Belies Steep Falls Ahead as Coronavirus Impact Crystalises

- UK inflation dips to 1.7% in February, from 1.8% previously.

- On lower food, energy prices, but core inflation rises to 1.7%.

- Core CPI up from 1.6% on media, restaurant, hotel increases.

- CPI to fall amid coronavirus crisis but post-crisis risks build.

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Inflation ticked lower in February thanks to a fall in energy and food price growth, according to Office of National Statistics data released Wednesday, but it's tipped by economists for steep falls in the months ahead as the coronavirus impact shows up in economic data.

Inflation dipped to 1.7% last month from 1.8% previously, in line with the market consensus, but the more-important core consumer price index rose from 1.6% to 1.7% when economists had looked for it to decline to 1.5%. Core inflation measures remove commoditised energy and food items from the goods basket as well as products that have regulated prices, like alcohol and tobacco, because price changes in those categories can distort underlying trends.

The ONS says restaurants and hotel prices, which come under the services rather than goods category, provided the greatest upward contribution to inflation in February while alcohol, tobacco, housing and household services made the most significant negative contribution to last month's changes. 

"CPI inflation looks set to decline sharply over the coming months and to fall comfortably below 1% in the summer. The collapse in Brent crude prices to $28, together with the reduction in Ofgem’s cap on electricity and natural gas prices in April, looks set to mean that the energy component will be subtracting about 0.7pp from the headline rate by May, down from the current 0.2pp boost," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. 

Currency markets care about inflation data because it's the outlook for consumer price growth that dictates central bank interest rate policies which are the predominant driver of exchange rates, with rising rates being the typical prescription for containing price growth that threatens target levels while lower rates and other measures are deployed to revive inflation pressures.

The Bank of England has a 2% inflation target and has cut interest rates repeatedly in recent weeks to ensure it can deliver this over the medium term, given that the coronavirus crisis could destroy jobs and incomes and potentially lead to a loss of demand that undermines inflation pressures in the economy over a one-to-two year horizon. The BoE has also enlarged its crisis-era quantitative easing program so that its total government and corporate bond holdings rise from £435bn to £645bn.

"The closure of all non-essential shops, restaurants, and recreational and cultural venues implies that prices in these sectors will remain frozen at their pre-virus levels for as long as the government's shutdown lasts," Tombs says. "All told, then, the inflation outlook likely will not dissuade the MPC from ramping up its asset purchase programme or considering unconventional stimulus measures, if its recent salvo falls short."

Wednesday's figures were released with the country entering its very own 'lockdown' that's seen Prime Minister Boris Johnson 'order' that citizens and residents stay at home where possible and avoid all unnecessary social contact. The 'coronavirus bill' that will grant ministers and other state authorities the power to enforce such instructions was set for the committee stage of the legislative process in the House of Lords Wednesday and could become law as soon as Thursday evening. 

Prime Minister Johnson has instructed pubs, restaurants, cafes and later, many other businesses to close across the country in the hope of slowing the spread of coronavirus. This is expected by many economists to produce a double-digit economic contraction in the second and third quarters but likely means a freeze in selling prices of non-food goods for the time being while -60% falls in oil prices could reduce consumer price pressures in the short-term.

However, once the coronavirus crisis passes the economy could face simultaneous supply and demand shocks as activity normalises, with consequences for consumer prices in subsequent quarters. This is because a demand explosion could occur before the supply of both essential and non-essential goods and services has had time to normalise, although some economists say retailers and service providers would likely swallow any increases in costs themselves rather than pass them on to consumers.

"One element which might potentially go in the opposite direction is food prices, which have probably held up well in response to the recent high demand especially for things like pasta, rice and tinned goods. And the near 10% drop in the sterling trade-weighted index over the past month could place some upward pressure on inflation. However, retailers may be forced to absorb some of the price rises," says Ruth Gregory at Capital Economics. "We think that inflation will average just 1.2% in both 2020 and 2021 meaning that even by next year, there may be little pressure on the MPC to raise interest rates."