The Daily Update - UK Inflation Outlook

There’s been a lot of hype around yesterday’s UK inflation figure coming in at 3.1%yoy approaching 5 year highs…perhaps aggrandised by the media as coming just before Christmas, but also worries that it might persist. Last Christmas (and for most of 2015 and 2016) Mark Carney had to write a letter to the Chancellor of the Exchequer because inflation had persisted below 1%. But this year, with inflation outstripping wages, the papers make clear that tiny Tims around the country may not get the presents they wanted.

This is certainly true if said present was going to be a computer game or plane tickets for a holiday abroad as these were the major contributors to the higher CPI figure. Transport alone contributed 0.7% to inflation (although lower mom from October) but more essentially rising food prices have also hit consumers being the third largest contributing factor to inflation at 0.41% (recreation being second at 0.46%). Items such as financial services costs had an offsetting downward contribution, but such items are less impactful for those feeling the pinch hardest (and not particularly conciliatory for those of us in financial services).  Perhaps those most affected doesn’t just include consumers but also the retail sector; which may have to slash prices just to attract business.

But the idea of this inflation persisting looks much less substantiated. Recalling the sharp depreciation of the pound in late June 2016 following the Brexit vote, and the typical lag in how this affects inflation across various sectors, many economists expect the present CPI reading to be near or at its peak. One highly correlated leading indicator for CPI core is simply the trade-weighted sterling index advanced by 12 months. This peaked 12 months ago and should core inflation follow suit, and sterling remain around current levels, one could see inflation fall back below 1% so that next Christmas the Chancellor will again be getting a letter for why inflation is below, rather than above, target.

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