Monthly Archives: February 2016

Latest UK inflation data – January 2016

UPDATE:
Here Pete talk about the latest figures on Share Radio:

The latest inflation figures show a rise in UK inflation rates with CPI now 0.3% (0.2%) and RPI 1.3% (1.2%). However in reality prices fell in January by 0.6%. The paradoxical rise in the annual CPI comes about because prices dropped less this January than they did at the same time last year. For example petrol/diesel was down -2%, but it dropped -7% in January 2015. The same pattern was seen for food and clothes. In addition, alcohol prices that normally bounce up in January did so more than last year too.

Prices may well have risen more in January had it not been for an unusual -0.8% monthly decline in service prices. Some of this was related to declines in telecoms prices and accommodation but the biggest contributor was airfares. ONS published some dubiously high rises in December, which have now been sorted out and possibly too far in the opposite direction. Airfares therefore appear to have declined 36% off the back of these calculations. Although airfares have only about 1% weight in the CPI index, such large declines do drag it down. Without it CPI would probably have been at least 0.4%.

New CPI weights

January also sees ONS bring in a new set of weights for CPI. This year sees a continuation of their recent trend of giving less weight to the goods people buy and more to services. This makes sense as service inflation is rising at 2.3% and people are having to spend more on it. However it is worth thinking what the compound effect is. Over the last 5 years, the weight of all services in CPI have increased from 44.1% to nearly 48.3%. Next year may well see them about 50% for the first time ever. That higher weight for services will help increase published inflation levels – see comments below.

weights
As the above chart shows, the biggest declines in weights have been for food and fuel. In contrast, weights have increased for holidays, recreation, transport costs, healthcare and rent.

Future inflation rate

But the big question for inflation watchers from today’s data is where might inflation go in the coming months and be by the end of the year. In answering this question, it is key to consider some of the factors that drive the headline rate. The most important are probably:

  1. Changes in commodities prices such as oil and food. This can influence the rate very quickly and markedly for a period of time (or at least until the changes finally drop out of the calculation).
  2. Certain specific items. Things such as clothes and airfares can cause ONS lots of headaches to measure. They often exhibit volatile changes that frequently reverse the next month and can often be ignored.
  3. Government controlled prices. These often increase the rate of inflation e.g. above inflation train price rises, education , etc.
  4. The sterling trade weighted index. This often has a longer term effect on inflation, as pass through is slow.
  5. The economy. When the economy is growing, labour is tight and wages are rising fast, this inevitably spills over into price rises. The converse is also true.

Given the above analysis, the most important influence on CPI going forward is what happens to oil prices and whether the recent stock market declines then results in some form of global recession. There has been a marked change in the consensus in last few months. Many commentators now seem to think that oil may continue its downtrend (to $20?) as might stock prices. Whether the latter then triggers a recession probably depends a lot on what happens to banks and the debt markets. Either way, the chances of more competitive devaluations pushing down the prices of imported goods has increased.

I therefore am forced to switch my view that inflation might be back up to 1% by April. It may well rise in February a little, but oil prices may well force it lower again. However it must be remembered that there will come a point when oil declines stop influencing the headline inflation rate. For example if Brent crude declines to $20 (from $34 today), that is likely to merely reduce petrol prices from 102p->95p. It is very unlikely to decline any further due to the bulk of the remaining cost being fixed tax and retailer charges. Thereafter, to quote the singer Yazz, the only way is up. This, together with underlying service inflation at 2.3% may well cause inflation to return towards 2% again but probably not this year now.

The full ONS stats can be found here.