MNI ANALYSIS: UK Infln More Likely to Rise Than Fall In July

By Jamie Satchithanantham

     LONDON (MNI) - Despite slowing in June, the general consensus is that the

upward march of UK inflation still has some legs and CPI could even reach 3.0%

before the close of the year. July could have seen its upward march resume.

     The ascent in prices, triggered soon after the European Union referendum

last June, as sterling fell sharply on the forex markets on fears over the UK's

long term economic health and heightened uncertainty surrounding its future

trading relations.

     Over the last 12 months, inflation jumped from 0.5% in June 2016 to 2.6% in

June this year. Though fundamentals held up well over the early course of this

period, this persistent cost-push inflation has seen macroeconomic conditions

deteriorate since the turn of the year.

     Earnings growth has dissipated, contracting in real terms, pushing

households to dip into their savings in order to maintain their standard of

living (the household savings rate now stands at a record low 0.2%). Consumer

confidence remains muted and spending on non-essential items and durable goods

has been reigned in. The housing market and auto sales have also softened in

recent months; and while export volumes are higher, import volumes have also

held up well thus far.     

     The Bank of England, in its latest set of forecasts published in its August

Inflation Report, outlined its expectations for CPI to peak at 3.0% in October,

before the currency effect pass-through fades out and inflation slowly unwinds

through 2018. 

     In falling to 2.6% in June from 2.9% in May, inflation recorded its first

decline in eight months, courtesy of a drop in motor fuel prices and selected

recreational goods and services. Considering all the factors at play, inflation

could rebound in July but there will be some friction.  

     Below, we look at the factors that played a role in June as well as what is

set to influence the numbers in July.   

     Of the 0.23 percentage point fall in CPI inflation between May and June,

the transport component of the basket accounted for -0.16pp -- and just over two

thirds of that was due to falling fuel prices. Motor fuels, the relevant

sub-component of the transport segment, fell 1.1% in June (petrol and diesel

prices were down 1.0% and 1.2% in June respectively), marking the fourth

straight month of falling prices. 

     The ONS publishes motor fuel pump prices in advance of the CPI release thus

making it possible to calculate their impact on inflation in advance. Between

June and July, petrol pump prices fell 1.2% while diesel prices were down 1.4%.

One year ago, the month-on-month price change between the same two months was

0.7% and 0.8%, respectively. As such, the fall in petrol prices this June/July

look set to knock off approximately 0.06pp from July's 12-month change in CPI.  

     Crude oil prices have been on a downward trend since the turn of the year

but picked up around the tail end of June. Weekly fuel price data shows that

pump prices began to pick up in August, so after softening again in July motor

fuels could return to providing inflationary pressure in August.

     Within the recreational and culture category, data processing, games and

toys and cultural services all weighed on inflation in June, cumulatively

accounting for -0.11 of the -0.23 drop in CPI between May and June. Offsetting

these forces were rising prices of furniture and furnishing items, up 3.2% y/y

in June and accounting for 0.05pp of the change.

     Traditionally, clothing promotions adorn stores in the summer with

retailers cutting prices, taking advantage of the warmer weather. The clothing

and footwear index will almost certainly fall in July, as it has done every year

since records began. It fell 3.4 points between June and July in both 2015 and

2016 and fell by an average 3.66 over the past five July's. 

     In June, the clothing and footwear sub-index, which carries a 0.072

weighting, slipped 1.1 points to 102.1 and even if it were to slip another 3.66

points to 98.44 in July the category would knock 0.01pp off the change in CPI in

July. 

     According to James Tucker, Head CPI Statistician at the Office of National

Statistics, speaking exclusively to MNI, "movements in clothing prices tend to

be influenced by seasonal sales patterns ... the periods with the most sales

tend to be January, February, July, August and December". 

     "We haven't seen anything particularly unusual in terms of clothing sales

patterns in this year up to June, although there has in general been slightly

less sales activity compared with 2016," he added. 

     ENERGY PRICE RISES TO PUSH UPWARD PRESSURE ON CPI

     One area where July's data will see increased inflationary pressure is in

the energy component of the basket. Energy supplier EDF Energy implemented a

price increase of 7.2% on standard variable rate dual fuel customers, effective

from June 21. The rise will affect around 45% of EDF's customer base according

to comparison site uSwitch. The 7.2% tariff rise and follows a prior 1.2% evoked

in March and a raft of hikes made by other energy providers earlier in the year

(British Gas, yet to raise prices this year, will do so in September).  

     Due to how the ONS collects its CPI data (it generally closes the

collection period on the second or third Tuesday of every month), this latest

price rise will be captured in the July dataset.

     STERLING IMPACT

     On a trade-weighted basis, sterling ended June on a stronger note than it

began the month, and continued this upward trend through July and early August.

Survey data continues to report firms passing on higher input prices to some

extent, though the intensity of this seems to be waning.

     The Bank of England's most recent Agent's Summary of Business Conditions

(which surveyed business between June and mid-July) reported input cost

inflation remained "heightened, though some of the manufacturing contacts

reported that initial pass-through of the past sterling fall into input costs

was nearing completion".   

     Consumer goods inflation continued to rise, according to the BOE survey, as

past rises in input costs fed through and foreign currency hedges ran off.

According to some contacts, goods price inflation was "reaching its peak" while

retail services inflation continued to edge higher.

     Supplementing this, the Input Prices component of the IHS Markit/CIPS July

Manufacturing Purchasing Managers' Index rose at the slowest pace in over a year

in July. Companies continued to integrate these increased costs into their final

products; the output prices measure rose for the 15th consecutive month in July.

     It's sister survey, measuring services activity in July, noted the rise in

input costs accelerated in July with a "marked" rise in operating expenses

leading to higher prices at the factory gate (they fell to an 11-month low in

June). Given services accounts for around 80% of economic activity, it would be

reasonable to place more weight on this in respect to the inflation data.

     Official year-over-year input price inflation slowed for the fifth

consecutive month in June, falling to 9.9%. It had been as high as 19.9% in

January. While this does depict the gradual pass through of the currency fall,

the lag between lower input and output prices means that the fall in the latter

has been less pronounced. 

     Output price inflation fell to 3.3% y/y in June, the lowest since last

December, but core factory gate prices did edge up to +2.9% y/y -- last higher

all the way back in September 2011.

     Overall, inflation in July is likely skewed slightly to the upside given

the fall back in June. The monthly change in the numerical CPI index has

averaged +0.2pts both over the past 12 months and six months and +0.3pts over

Q2. 

     Even if the index was to hold firm at 103.5 in July, this would be enough

to nudge inflation up 0.1pp to 2.7%. A 0.2pt rise in the index would be enough

to see inflation hit 2.9% while a 0.3pt rise would see it hit 3.0%.

     Historically, however, July tends to see a drop in the index. Between June

and July, dating back to 1988 when records began, the average change in the

index was -0.2pts. This would be consistent with CPI having dropped 0.1pp to

2.5% this July. 

     Over the last 10 years, the index has fallen an average 0.1pts in July. If

this were to materialise CPI would hold firm at 2.6%.   

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI London Bureau; +44 203-586-2226; email: jamie.satchithanantham@marketnews.com

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