Morning Equity Briefing |
Market Comment
UK CPI inflation rises to 4%
Conall Mac Coille
Speculation that the Bank of England will be forced into raising interest rates has intensified following the news yesterday (February 15th) that CPI inflation in January was 4%, well above the 2% target of the Monetary Policy Committee (MPC). The CPI inflation out-turn forced Governor Mervyn King to write a further letter to Chancellor George Osborne explaining the strength of inflation. Overall, there was little change in substance from previous letters with the Governor reiterating his view that the current strength of inflation was due to the increase in value added tax rates, energy prices and the gradual pass-through from the low level of sterling into import prices and CPI. Indeed, the 4% CPI inflation came as no surprise to the market and had been well flagged in advance in recent speeches by MPC members. The key question is where CPI inflation will be in 12 months' time.
There have been stark differences in the commentary on the Governor's letter. Some media outlets have interpreted the letter as a signal by the bank that rate rises are likely in the future. This seems unlikely as the Governor's letter indicated there were strong differences in view on the MPC about the outlook for inflation. So, given these contrasting views, it would be very difficult for the bank to provide any clear signal to the market about the outlook for the policy rate. Other commentators suggested that the letter reinforced the Governor's view that the current strength of inflation was temporary and that rate rises were not required.
Greater clarity will hopefully be provided by today's Inflation Report press conference, where Mervyn King will explain the bank's latest projection for CPI inflation over the next three years. In addition, labour market data for the UK released this morning should show that inflationary pressures emanating from the labour market remain weak. The unemployment rate is expected to remain at its current high rate of 7.9% and average earnings growth to fall back slightly to 2.0%, well below pre-recession rates of around 5%. Furthermore, the Nationwide measure of consumer confidence released early today fell sharply to a reading of 47, a similar level to those during the worst of the financial crisis. So today's data releases will underline the fragile recovery in the UK against the backdrop of high CPI inflation rates, which together provide a challenging environment for the MPC to formulate monetary policy.