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Neil Williams, Hermes

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UK inflation data ’softer then expected’

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Hermes Chief Economist Neil Williams comments on the latest UK inflation statistics…

The latest data were an early Christmas surprise, and, by turning out softer than expected, will pare back most investors’ RPI and CPI projections for 2015. My inflation model now predicts just 1.7% average RPI inflation for 2015, with the policy-sensitive CPI inflation averaging just 0.9% next year.
 
Today’s data were of course ‘driven’ by fuel, but also by price deflation now in food, with food prices falling 1.7%yoy. The only meaningful price rises are in clothing and footwear (+0.8%mom) and tobacco (0.4%mom).
 
Together, this means the UK now has overall goods-price deflation (after taxes) for the first time since 2007. The overall, headline CPI targeted by the BoE is being held up only by stickier service prices (2.4%yoy). These being relatively more demand inelastic suggests at least some inflation resistance to firmer pound going forward.
 
But, in terms of policy, our model predicts the CPI will now trough as low as 0.3%yoy (a record low) in Feb 2015, with governor Carney having to write his first letter to chancellor Osborne.
 
We still at this stage have two 25bp rate hikes in mind for the back end of 2015 (one Aug, one Nov), which would cap the CPI’s bounce-back at 2% by Christmas 2015. This now rests on how extended the oil-price drop proves to be, but just one hike (next Nov) is looking more likely now.

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