Expect Inflation to Leap from April Onwards

- Surprisingly week inflation reported in Feb.
- Clothing discounting blamed
- But a jump in inflation is coming say economists

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UK inflation in February was a great deal softer than analysts were expecting, but the consensus amongst economists remains that a steady rise in prices lies ahead.

CPI inflation grew just 0.1% in the month to February according to the ONS, a pick up on January's -0.2% but well below the consensus estimate expected by markets at 0.5%.

In the year to February prices rose 0.4%, which is below both January's reading of 0.7% and the consensus expectation for 0.8%.

The text book takeaway from a foreign exchange market perspective is that the softer-than-expected inflation readings present the Bank of England with a headache: their task is to push inflation to a 2.0% target, and it could therefore be assumed that record-low interest rates and substantial amounts of quantitative easing are not working.

Building on this assumption, it could be expected the Bank will look at pursuing lower rates and more quantitative easing, both of which would typically weigh on UK bond yields and the British Pound.

But the ONS says the undershoot in February's inflation can largely be blamed on discounting in the clothing retail segment, as such the blip could be temporary and ultimately unlikely to bother policy makers at Threadneedle Street.

"Steep discounting on clothing helped drive inflation quite a bit lower in February, but this is arguably only a blip on the road to 2% later this year," says James Smith, Developed Markets Economist at ING Bank.

The UK economy is being tipped by economists to be boosted by a sizeable jump in consumer spending in 2021 as pent-up savings accumulated during the crisis are unwound, prompting economists at Deutsche Bank to warn that the Bank of England might be underestimating the scale of an impending consumer-lead rebound.

Analysis from Deutsche Bank released this week shows that the scale of the boost to UK economic growth from the spending of savings could amount to 1.0% of GDP, more than twice that expected by the Bank of England.

An unexpectedly strong economic rebound could in turn drive inflation meaningfully above the Bank of England's 2.0% target.

ING say they expect UK inflation to leap from April onwards thanks to rising energy prices, partly because we’ll no longer be comparing petrol prices to pre-pandemic levels, but also because the household energy price cap will rise to 9%.

A spillover effect from higher transportation costs (owing to both Brexit and worldwide shipping disruption) can also be expected, pushing headline inflation "a tad above, the 2% target by the end of the year," says Smith.

Paul Dales, Chief UK Economist at Capital Economics says energy effects will have a much bigger upward influence on inflation when the level of fuel prices this April is compared to the low point reached last April.

He adds Ofgem’s scheduled 9.2% hike in utilities prices takes place in the same month.

"Although today’s release means that the Governor of the Bank of England will have to write another letter to the Chancellor explaining why inflation is more than 1.0% below the 2.0% target, he can say that the fading drag from lockdowns and a rebound in energy inflation will soon lift inflation much closer to 2.0% in April."

That said, Capital Economics tell clients they doubt inflation will be persistently above 2.0% until 2023.

"So don’t expect rate hikes for a long time yet," says Dales.

ING agree, saying the latest dip, based on temporary factors, matters very little for policymakers, and the prospect of a rise in CPI through this year is another argument against adding further stimulus later this year.

"The more moderate medium-term outlook suggests little pressure to begin looking at tightening, and indeed this is unlikely to come before 2023," says Smith.