Global disinflationary pressures continue to keep consumer prices subdued at the start of this year, as prices of energy and food remain lower.
Both domestic and external factors sent the UK inflation to its record low of 0.5% in December. In January, economists expect the annual Consumer Price Index (CPI) inflation to decelerate further. The price index "will likely fall further, potentially turn negative in the spring, and be close to zero for the remainder of the year, the Bank of England's Governor Mark Carney said during his opening speech at the February Inflation Report.
The Office for National Statistics (ONS) is releasing January CPI data on Tuesday, 9:30am GMT.
Cheap Oil effect
The largest downward effect comes from cheap oil. In January, crude oil was selling at an average of $44.4 a barrel, which was down from $59.5 a barrel in December. This comparison shows a rather sharp decline over the month and indicates further downward pressure on fuel prices in January.
According to the latest data, average crude prices for now appear to have hit the bottom in January, as the average price in February-to-date jumped back up to $52 a barrel. The January AA Fuel Price Report, one of the most-watched gauges of petrol prices in the UK, said that given the oil price movement, it was unlikely for petrol to fall to, or even below, a psychological level of £1 a liter.
Gas bills cut
Apart from petrol, further downward pressure looms as several major gas suppliers in the UK announced cuts in the cost of household gas bills. The largest one, British Gas, will start charging its UK consumers 5% less as of February 27. E.On, the third largest gas provider, started charging 3.5% less on monthly bills on January 13 - both arguing that cuts come at the time of falling gas wholesale prices.
Shop price deflation
The CPI has also been subdued due to cheaper food. The British Retail Consortium (BRC) published its Shop Price Index report earlier this month, in which it said food prices were 0.5% in deflationary territory in January, while non-food prices remained deep in deflation of 1.8%. On the price outlook, the BRC saw further deflationary pressure for the rest of this year, as PPI remains below zero.
"Retail businesses will continue to see decreases in their own input costs for the foreseeable future. To remain competitive, retailers will continue passing these savings on to the consumer. 2015 is shaping up to be win-win year for shoppers and retailers alike," BRC Director General, Helen Dickinson, commented on the January Shop Price Index report.
BoE's near vs medium-term inflation forecast
The BoE's February forecast showed CPI inflation falling temporarily below zero in spring and remaining around this level for the rest of the year. It then bounces back up around the turn of the year, as the effects of cheap energy prices drop out of the annual rate comparison. The BoE also unexpectedly admitted that it can cut the base rate even further, or expand the asset purchase program, if low inflation persists. It argued that stronger capitalization of the UK banks today allows for such extraordinary measures.
“But as unusual as that is, it arguably isn’t the main story," BoE Governor Mark Carney said during the February Inflation Report press conference, referring to cheap-oil-suppressed inflation. Carney then turned somewhat hawkish and stressed that "the headlines today mask stronger underlying dynamics which will determine UK output and inflation tomorrow."
The BoE policymakers expect low inflation in 2015 to generate stronger growth through higher real incomes and increased consumers' spending. In the medium-term, inflation is expected to overshoot the 2% target by the middle of 2017 if the curve was to reflect market interest rates expectations, which shows the first hike to come as late as in the third quarter of 2016.
Partly for this reason, rates will have to increase sooner than markets expect today, the BoE's external member of the rate-setting committee Martin Weale wrote for the Observer on Sunday last week.
“These risks of an increase in inflation sharper than we have forecast remain. As the price of oil fell, however, I became increasingly concerned about the offsetting downside risk that expectations of low inflation might become built in. The further the price of oil fell, and the lower the inflation rate sank, the bigger this risk became,” Weale explained his vote to join the MPC majority in January.
Weale had been arguing that the central bank should see through the temporary pressures and look beyond to medium-term inflation risks. He argued that a stronger labor market and rising wages should generate enough upward pressure to bring inflation back to target over the forecast horizon.
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