UK inflation hit its highest level in two and a half years in January, but came in lower than expectations.

Here’s a round up of the best analyst reaction as speculation on whether the Bank of England will have to tighten monetary policy remains elevated.

Headline consumer price inflation hit 1.8 per cent in January, softer than economist expectations of 1.9 per cent. The BoE has predicted inflation will hit 2.7 per cent this year, falling to 2.6 per cent in 2018 and 2.4 per cent in 2019. Its target is 2 per cent.

Analysts at Investec think price growth will surpass the Bank’s target “soon”, stating:

We continue to expect inflation to climb further and to surpass the 3% mark later this year.

They add:

The Bank is maintaining a close watching brief on pay growth in particular, for signs that domestically generated inflation could provide a more persistent upward influence on inflation that warrants more of a tightening bias for monetary policy.

We don’t know the Bank’s exact tolerance level here, but clearly this is worth watching closely, with the latest average earnings numbers due tomorrow (15 February). In the three months to November pay growth had already reached 2.8% y/y.

From Shilen Shah, bond strategist at Investec Wealth & Investment:

Despite the headline CPI coming in slightly below consensus in January at 1.8% (consensus: 1.9%), there are clear signs that inflationary pressures are building in the UK economy with import prices increasing by 20% y-o-y, with crude oil leading the charge.

The Bank of England’s currently neutral stance is significantly supported by its latest estimate about the amount of spare capacity in the economy, however if the path of CPI is stronger than it currently estimates, we may eventually see a stronger reaction from the central bank.

From James Smith, economist at ING:

Despite today’s below-consensus inflation, we expect CPI to hit 3.1% by the end of this year. But it’s what this means for household incomes that really counts for the Bank of England.

Beneath the headlines, we’d focus on two key developments. The first is the 4.2% MoM fall in clothing prices. This is interesting because it corroborates other stories (e.g. from the British Retail Consortium) that the high street struggled during the January sales and discounts may therefore have been higher than usual.

Secondly, food prices provided the smallest drag on overall headline inflation in over 2 years. Since 2014, food prices have fallen dramatically as supermarkets became engaged in a bitter price war. Not any more though: sterling’s plunge has driven up the cost of imported food and this is finally being reflected in higher consumer prices.

Putting these two points together, this is further evidence that the major driver of growth in 2016 – the consumer – may be finally running out of steam. Surging inflation (in particularly food and fuel prices) are eating into disposable incomes and in turn that is starting to hit spending. We expect to see further evidence of this in this week’s retail sales data.

We’re expecting inflation to hit 3.1% by the end of 2017 – that’s quite a bit above the Bank of England’s projection, who are expecting CPI to peak at 2.8% during 2018. Whilst some of the Bank of England hawks are indicating that they have limited tolerance for higher inflation, we suspect that the negative effect this will have on consumers will ultimately outweigh concerns about above-target CPI. We therefore expect the Bank of England to retain their “neutral” stance for the foreseeable future and we don’t anticipate any change in Bank rate before the end of 2018.

From Michael Martins, economist at the Institute of Directors:

Inflation maintains its rise as the devaluation of sterling continues to make imports more expensive, although January clothing sales helped to offset a steep rise in transport costs. The main imported items affected by sterling’s fall, petrol and food, are fixed costs for many, so a persistent increase will eat into disposable income and put downward pressure on consumption. Luckily, continued strong wage growth will likely offset upward price pressures, at least in the near term. 28% of IoD members intend to increase employment this year, only slightly lower than a year ago, a helpful proxy for pay growth.

Although the Bank of England has said that they are comfortable with overshooting their 2% target in the near term, a reduction in quantitative easing would help to offset inflationary pressures by reducing the money supply.

This would allow private investors back into the short-term gilt market, helping to correct a fairly distortive policy intervention, and freeing up the ability to intervene in the future if necessary. A gradual disinflation of asset prices, particularly housing, would help to reduce another fixed cost, effectively boosting real wages for many. A reduction in QE would also have immediate effect, avoiding the lagged effects of raising interest rates.

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