James Knightley at ING writes in a client note that the CPI numbers will support a holding stance from the BOE.
He says inflation looks set to remain contained as the pounds strength makes imported goods cheaper while weak wage growth and lower energy prices limit business cost growth. PPI data suggests an absence of pipeline inflation pressure in the economy and further eases pressure on the BOE to consider near term rate rises. On a side note, ING are predicting a rate rise in November.
A similar note has also been issued by Samuel Tombs at Capital Economics, who says among other things, that the disinflationary effects of GDP appreciation have not fed through fully to the shops yet.
I believe we’re dealing with two aspects now in the rate rise picture. The BOE has said that they won’t necessarily wait for wage growth before hiking but they are assuming it will come. Will they think the same way about inflation?
PPI prices fell quite a bit but the all important difference between input and output prices needs to be taken into consideration. Compare us to Europe and this falling price data isn’t a bad thing. The core inflation has held up meaning that domestically prices are relatively firm and the fall was mainly driven by later discounting, and probably at a more extreme level than we would get normally.
Input prices falling is good for our economy as we are a major net importer and this is a big benefit of currency strength. While many say it hurts exports the currency problem can be negated by the ability to lower prices due to the input costs falling. That’s why I mention the PPI in vs out differential. Output prices haven’t fallen as much as input prices. If you address it in a simple form it’s like profit margins. Your costs fall while your selling prices remain steady. It becomes minute adjustments of margins.
The difference between us and Europe is that we have some growth with which to play with. Price adjustments can be made that don’t have a huge effect on business and the economy. Europe has little growth and low prices so there’s no room to maneuver. The tendency to cut prices to spark buying interest leads to a negative spiral in a weak economy, which Europe is in danger of falling into (if they are not there already). If UK output prices were falling as much in input prices I’d be worried.
So how will that play in the minds of the MPC? If anything it shows that the economy is working as it should. This fall in CPI may be temporary but there’s other factors to say that it’s not going to scream higher. Will that stop the BOE from hiking when they want? I doubt it. They know wage growth is coming, they know that any pick up in Europe will help boost the economy and they know that they really need to start moving rates up. As adam repeatedly points out about the US, the economy can likely very much weather 1% interest rates and the UK should be able to do the same.
Irrespective of what we think about the when, where’s and why’s, central banks know they need to raise rates. What they are doing now is trying to fine tune when that may happen. The data today hasn’t changed anything and it only will if we see a dramatic fall in inflation, but that’s unlikely.
The pound has fallen as expectations of rate adjustments get pushed back and I think the market has overdone it. I’ve taken a long down here that I’ll see how we go before we run into the MPC minutes tomorrow. I may add to that if we see it drop further but I’ll see where we are at in the minutes before the MPC data before deciding whether to cut or hold over the release.
