Inflation in the UK is expected to remain steady and significantly weak, ahead of the Bank of England's fresh forecasts that will shed more light on policymakers' views and reasoning.
The annual rate of UK CPI is expected to have remained unchanged at 0.1% in June. Inflation in Britain dropped below zero in April for the first time since the 1960s, only to reverse back one percentage point above zero in May. Both movements in the headline CPI in April and May were caused primarily by one-off effects such as the different timing of Easter this year and last, which in turn had a notable impact on travel costs and the overall index. Core inflation, a less volatile gauge stripped of energy and food prices, is also seen stuck at 0.9% - the lowest in almost six years.
July's release of CPI data is also the last before the Bank of England publishes its fresh outlook for inflation on August 6, within its quarterly Inflation Report. The BoE is also introducing new communication procedures as of this coming August, when a policy announcement, MPC minutes and, in the case of the August data cycle, Inflation Report forecasts will be announced on the same day.
Cooling shop price deflation, as measured by the British Retail Consortium (BRC), and slowly rising petrol prices should generate enough upward pressure for the UK to slowly push inflation upward. Economists expect inflation to begin rising notably toward the end of this year, when the effect of last year's sharp decline in crude oil prices begin to fade out.
According to the AA Fuel Report, average UK petrol prices reached a six-month high in June after moving back above 117 pence a litre. Diesel’s price rise is smaller, but hides the fact that the wholesale cost is around 2 pence a liter lower than petrol’s, the AA report said. Seasonal travel costs are also seen as a notable upward mover as we move into the heat of summer.
Arguments for gradualism
Although slow and gradual, a rebound in UK inflationary pressure should pump up the hawkish mood among BoE policymakers. Despite the fact that the near-term inflation is to remain significantly weak in the next few months, the central bank continues to prepare markets for normalization of its monetary policy sooner or later.
The majority of economists expect the first round of rate increases to come sometime in the first quarter of 2016, if inflation picks up as expected and macro data do not deteriorate markedly, with some of the MPC hawks expected to raise their hands to endorse a hike as early as in August.
A common stance among economists is that the BoE will be tightening policy with 25 basis points each rate hike. But given the policymakers' constant reiteration on gradualism and a slower tightening process, analysts at the Bank of America (NYSE:BAC) Merrill Lynch argued the MPC might as well start the tightening cycle with a 10 basis-point hike instead.
"We see several compelling reasons why it might be considered and expand upon our original case inside. A small and tentative first increase might plot a careful course between compelling but competing economic arguments and minimize the risk of what we call a 'Bayesian shock' accompanying the first rate increase," economists at the Bank of America Merrill Lynch suggested in one of their latest 'Liquid Insight' reports.
The above argument would make sense, given that BoE top officials are constantly stressing that the actual path of rate rises is more important than the timing of the first hike. That path will be much smoother, slower, and more gradual than in previous tightening cycles, with rates staying lower for much longer than was common practice before the crisis.
Rift at BoE looms
Based on the most recent speeches and interviews by BoE rate-setters, one can expect a rift between doves and hawks as early as the summer's end.
BoE policymaker Martin Weale told the Financial Times on June 23 that the Bank of England should be ready to start raising the base interest rate as early as in August this year, as the labor market continues to tighten markedly.
Weale is viewed as one of the most hawkish members of the BoE's nine-strong Monetary Policy Committee (MPC). Weale, together with policymaker Ian McCafferty, had voted for an interest rate hike between August and December last year, before the pair dropped their vote when inflation was falling sharply below the 2% target.
Weale's colleague at the MPC, Andrew Haldane, was much less enthusiastic about tightening the policy earlier than necessary. Haldane, who is the BoE chief economist and is considered a dove among BoE rate-setters, rejected calls for an earlier rate hike in his most recent speech at the Open University on June 30.
Haldane argued that the recent pick-up in wage growth is weak proof that domestically-driven consumer price pressures are strong enough to push inflation up toward the 2% target in a two-year time period. "April's wage data was news, encouraging news … But one swallow does not a summer make ... Wage growth is causing some fluttering, but not in this dovecote," he said.
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