UK consumer price inflation was unchanged at 2.7% in September, while the “core” rate monitored here – which excludes energy, unprocessed food and undergraduate tuition fees – edged up from 2.0% to 2.1%. Headline inflation is forecast to moderate near term, averaging about 2.5% over the next six months, before rebounding to more than 3% later in 2014 in lagged response to faster monetary expansion in 2012-13 and associated economic strength – see first chart.
The expected near-term decline, despite another hike in household energy tariffs, reflects lower petrol costs, a likely slowdown in food inflation and an assumed dampening impact on other import prices from recent sterling appreciation. The rise in energy tariffs will be similar to last year so will have limited impact on headline inflation. An easing of food pressures, meanwhile, is suggested by recent declines in output price and input cost inflation in food manufacturing.
The forecast that inflation will trend higher during 2014 and early 2015 reflects the two-year leading relationship between monetary expansion and core price pressures – see previous post for more details. It incorporates a judgement that there is limited effective economic slack, so that solid growth will generate capacity strains and lift corporate pricing power. This is supported by the third-quarter British Chambers of Commerce survey released last week, showing that the proportions of firms in services and manufacturing working at full capacity are normal and high respectively – second chart.
Former MPC member David Blanchflower has accused the author of this journal of “crying wolf again” by forecasting that inflation will rise in 2014-15. The consistent view here in recent years has been that the stance of monetary policy was incompatible with returning inflation to the 2% target; this judgement has proved correct. The last forecast of a major inflation upswing was made in autumn 2010, ahead of a surge in the headline CPI rate to a peak of 5.2% in September 2011*.
*The forecast was that inflation would average 3.9% in 2011, which compared with Bank of England and consensus projections at the time of 2.8% and 2.6% respectively. The outturn was 4.5%.