UK CPI Review: Inflation Back Above Target & Core Pressures Higher
Coming in higher than expected and a notch above BoE thinking, CPI inflation jumped to 2.3% in October. Helped by a fall in fuel prices and airfares, amplified by base effects, alongside some belated broader softening in services costs, UK inflation had dropped to 1.7% in the September CPI (from 2.2%), thus falling below target for the first time since April 2021. However, this drop proved to be both short-lived and with the latest data showing a fresh rise (of 0.1 ppt) in both the core and services inflation to 3.3% and 5.0% respectively (Figure 1), the latter up from a 28-mth low. Regardless, a rise in the headline was almost inevitable as last month’s rise in the energy price cap (partly dampened by a drop in fuel prices) was always going to pull the headline rate back and with the prospect of a further rise by a notch or two higher for the whole of Q4 – the BoE sees a 2.4% rate. Nevertheless, the data backdrop is consistent with underlying inflation still having fallen, especially when assessed in shorter-term dynamics (Figure 2) and where supply side factors still suggest disinflation to continue (Figure 3).
Figure 1: Core Inflation Drop Reverses?
Source: ONS, Continuum Economics
The last CPI picture was weaker than BoE thinking by almost 0.5 ppt, and broadly so and made the much-vaunted Bank Rate cut at this month’s MPC meeting almost a given. But despite clear signs of abating price pressures, the MPC stuck to a gradualist easing outlook approach, partly based on what we think are optimistic assumptions about the Budget measures impact on growth and perhaps an unwillingness to consider how much weak demand may yet add to a disinflation process driven by supply factors.
The Details
But the details will continue to perturb the MPC, not least the hawks, even though the rise in services and core was probably more reflective of data volatility that fresh resilience. Prices of second-hand cars rose by 0.2% in October 2024 compared with a fall of 3.0% a year ago. Although monthly prices for airfares in October tend to fall, the monthly price in October 2024 rose by 6.3%. This was the highest rise in October since monthly price collection began in 2001. For motor fuels, the latest movements resulted in overall motor fuel prices falling by 13.7% in the year to October 2024, compared with a fall of 10.4% in the year to September. Even so, out of the 12 main CPI components, eight rose back in October.
BoE Needs More Disinflation Evidence?
The headline measure of services inflation has been driven mainly by volatile and indexed categories of late, so the MPC has built a gauge that excludes those categories and this has seemingly fallen more markedly and now for a few months in a row. Moreover, looking at shorter-term price dynamics, services inflation has fallen towards a near-target rate, this in turn pulling core measures even lower, either on a smoothed m/m basis or the 3-mth ann rate favoured by the BoE (Figure 2). Moreover, around 0.5 ppt of services inflation is a result of rising rents, something some (not least ourselves) suggest is pro-cyclical element of the BoE policy stance. But amid a much softer inflation backdrop now emerging, albeit one we have stressed as being likely, it may actually be real economy matters that determined the pace of BoE easing ahead.
Figure 2: Adjusted Core CPI Pressures Still Falling
Source: ONS, Continuum Economics, smoothed is 3 mth mov average
After all, monthly GDP data suggest that the economy has not grown since May and by only 0.2% since March and actually contacted in the last 3-4 month outside of the public sector. These numbers are hardly consistent with there having been any momentum at all through the period, let alone momentum that has recently been lost. Indeed, business survey and payroll data also suggest little, if not actually fading, momentum. Budget worries may have played a role, but, if so, they may weigh on activity further, meaning that GDP growth this quarter may be hard pressed to match the anaemic Q3 reading, especially given the adverse base effect created by the unexpected September m/m drop. Indeed, there are clear risks to our central GDP outlook into 2025, with the more pessimistic outlook actually a mere continuation of the recent trend.
How Restrictive?
Regardless, the BoE will probably agree with us that much of the recent (and possibly looming) disinflation is supply driven (Figure 3 shows the extent to which easing global supply pressures as computed by the New York Fed has probably driven UK underlying inflation – both up and now down). This means that even with some reduction in the excess supply picture evident in the November Monetary Policy Report, domestic price pressures should add to this easing in supply strains – hence the only slightly and deferred below target inflation outlook the BoE last week looks pessimistic. Regardless, the extent to which the BoE must consider how restrictive policy must be with the clear proviso that even with the scale of cuts markets currently discount policy would still be far from neutral.
Figure 3: Global Supply Pressures Suggest Clear Fall in Cost Backdrop?
Source: NY Fed, ONS, CE