This week brings an intriguing update on inflation data in the United Kingdom with the consumer pricing index (CPI) being released on Tuesday.
Last week, Great Britain took center stage with the Bank of England’s “Super Thursday” meeting complete with remarks from the BoE about forward monetary policy.
This week the CPI, a closely watched proxy for economic health and growth, will give clear indications as to the rate of growth as the country continues to focus on the economic consequences of Brexit. The data release could also lead to wild swings and new directions in Pound Sterling.
With the Bank of England flashing a more hawkish tone last week, all eyes will be watching for a swelling inflation dynamic that could contribute to an accelerating tightening cycle in the U.K., primarily due to anxiety about a potentially overheating economy.
This speculation could contribute to a rising Sterling in the near term and would certainly make for an eventful week of trading.
Outlook for the U.K. CPI
We estimate an uptick in overall inflation for the U.K. driven by growth in core CPI (ex. Food and energy). We see the possibility for the core number to have moved from 2.5% to 2.8% year over year, which would drive the overall 12 month number beyond 3.0%. With most economist estimates congragating around 2.9%, a print north of 3.% would be a significant development.
In the last CPI reading from the U.K., we learned that the largest downward contribution came from the transport sector, namely airfares. We feel this downward pressure will abate somewhat due to rising fuel costs which translates to moderately increased prices.
The largest increases lately have come from household furniture and goods as well as tobacco, and we see no evidence of slowing in those sectors.
Movement in Energy Prices
The most fluid of all components of the CPI in the U.K. is energy.
According to the Office of National Statistics (ONS), the price paid for all domestic fuels in real terms has risen by 3.2 per cent in the year to Q3 2017, demonstrating a lively trend leading into this anum.
Between Q3 2016 and Q3 2017, based on ONS data, real prices including the Value Added Tax for domestic electricity increased by 7.0%, but that was partially offset by domestic gas prices which fell by 1.8%. Overall, consumers in the U.K. are seeing rising energy costs on their monthly bill. Part of this is attributable to a mandated increase in electricity rates in mid 2017, which will provide a lift to inflation on a year over year basis.
Change in household energy costs from 2016 to 2017:
Data courtesy of Office of National Statistics
In addition to the higher energy costs in British homes, higher raw and refined fuel prices are cascading across the economy.
The price of gasoline in December 2017 was 119.9 pence per litre which was 5.1 per cent higher than that of a year ago, while diesel at 123.7 pence per litre was 5.6 per cent higher compared to a year ago.
A healthy amount of these increases can be attributed to crude oil prices. The price of crude purchased by UK refineries in November 2017 was 37 per cent higher than that a year ago. Per the ONS the price in November 2017 at around $63 per barrel was 8.2% higher than the previous month.
These figures support a rising tide in energy prices when compared to the same period in the prior year, and we see a strong basis to expect a continuation of this trend through the first half of 2018. It is reasonable to assume this would be constructive to further expansion in the inflaiton metric.
Especially important for this quarter, price increases for electricity were instituted in mid 2017, so they will continue to be elevated versus prior year through the first half of 2017.
UK CPI Forecast
Last month, the reported 12 month CPI rate for December was 3.0%, and currently the consensus estimate for January is 2.9%, representing a small decline. Based on an analysis of proprietary predictive and mathematical models, our baseline estimate is above that level indicating there is an elevated probability for a surprise in the data. We expect a reading in the 3.1% to 3.2% range.
We see a rising inflation picture resuming in the first half of 2018. While the pace of expansion should be slower than it was in the first half of 2017, our models indicate it could ascend to a rate of around 3.25% as an apex in the May reading, to then relax at a level of roughly 2.8% by next January.
Much of the growth in inflation over the past 24 months was due to a weakening currency in the aftermath of the Brexit vote. A major risk to this outlook is a rebounding currency. However, we feel this is offset due to a lift in energy prices as well as continued ambiguity surrounding Brexit policies which will continue to cap and limit the potential for Sterling to rise beyond current ranges.
Outlook for Pound Sterling This Week
The Pound had risen to 1.4350 in late January, but has since corrected downward. Much of that can be attributed to dollar strength.
The level between 140.0 and 140.05 has served as an important level, and could serve as a consolidation zone in the future. It served as resistance that Sterling broke through on its second attempt on its way up in late January, and has since served as support where it survived one test before giving way last week as Sterling drifted back down.
With a stronger than anticipated CPI print, we could see a scenario where we accelerate to that level again, and we could see 140.0 serve as a consolidation zone giving way to choppy sideways price action by mid week, after the affects of the CPI release are fully realized.