UK CPI preview (Apr)
More evidence of persistent inflation pressures
|Headline CPI (y/y)||8.2%||8.3%|
|Core CPI (y/y)||6.2%||6.4%|
I look for headline inflation to plummet to 8.3% y/y as base effects from last year’s surge in energy prices finally kick in. While this would be below the MPC’s forecast of 8.4% y/y, I expect services to surprise the MPC to the upside—thus adding further pressure on policymakers to deliver another 25bps hike in June, in line with MY call and the consensus.
Strength in core inflation should validate the June policy rate hike. From a trading perspective, with double-digit inflation behind us, I still favor 2s10s Gilt Steepeners.
Similar to the June FOMC decision, the upcoming policy decision of the Bank of England (BoE) relies heavily on forthcoming data releases. While the Monetary Policy Committee (MPC) will have a complete set of June data before their next meeting, this week’s inflation data will also play a crucial role in their policy decision for June. If there is a significant deviation, particularly on the downside, from market expectations, it could lead to substantial movement in terminal pricing.
Interpreting this month’s release might pose challenges: although I anticipate risks favouring higher outcomes compared to the market consensus, inflation is still expected to fall below the BoE’s recent forecast. Specifically, I predict that headline inflation will drop from 10.1% year-on-year in March to 8.3% in April (market expectation: 8.2%, BoE forecast: 8.4%), primarily due to the base effects resulting from last year’s surge in energy prices. As for core inflation, I identify significant risks of it trending higher and forecast a 6.4% year-on-year acceleration (market expectation: 6.2%), driven by a 1.6% month-on-month increase in services prices (BoE forecast: 1.4%; refer to the chart below). Consequently, since the MPC will be particularly focused on core inflation, particularly within the services sector, going forward, a lower-than-expected headline inflation rate would be welcomed by policymakers. However, a robust core inflation figure, especially when propelled by notable strength in the services component, would exert further pressure on the MPC to implement another 25-basis points adjustment at its June meeting. This aligns with my prediction and the consensus.
I divide my forecast into three key components that are subject to change.
1. Energy will do much of the heavy lifting on headline inflation
Taking a closer look at the specifics of this month’s data, the main factor behind the significant decrease in headline inflation will be deflation in the energy component. This can be attributed to the exclusion of last April’s substantial increase in energy prices from the year-on-year calculations. Of particular importance is the contribution from electricity and natural gas prices, which remained constant last month due to the Energy Price Guarantee, in stark contrast to the approximately 40% and 70% surge experienced last year. Additionally, lower oil prices have led to a continued decline in petrol prices for the fifth consecutive time. In total, the energy sector alone is expected to exert a downward pressure of approximately 1.8 percentage points on year-on-year headline inflation (refer to the chart below).
2. Food inflation: Much weaker than the MPC expects
In my perspective, the Monetary Policy Committee’s (MPC) forecast for food inflation appears to be overly optimistic. In the May Monetary Policy Report (MPR), the MPC assumed a 1.1% month-on-month increase in prices for food and non-alcoholic beverages, whereas I anticipate a much more modest rise of 0.3% month-on-month (refer to the chart below). The divergence in my forecasts primarily stems from two main categories: 1) fruits and vegetables, and 2) milk.
The prices of fruits and vegetables experienced a significant surge in February and March due to supply shortages caused by adverse weather conditions in Africa and Southern Europe. For instance, lettuce, peppers, and cucumbers witnessed price increases of approximately 10% over the two-month period. As this shortage was not limited to the UK alone, similar price hikes were observed for fruits and vegetables across Europe. However, starting towards the end of March, the supply constraints began to alleviate, leading to substantial price declines in food items across other European countries in the April data (e.g., Eurozone: -0.04%, Germany: -0.75%, Sweden: -1.34%). While the deflationary impact on UK data may not be as pronounced, I still anticipate a comparable trend to the rest of Europe.
The second significant factor contributing to my “more” subdued food inflation forecast is related to milk prices. Around the 12th to 15th of April, major grocery retailers implemented approximately 5% price reductions for milk. Typically, determining whether the Office for National Statistics (ONS) records prices before or after such changes can be uncertain, depending on the selection of the index day, which is the day around which the ONS collects price data. However, this time, since the 10th of April coincided with a Bank Holiday, we can deduce that the index day must have been the 18th of April.
Consequently, the April data will include the lower milk prices. Roughly estimated, this alone would result in a reduction of food inflation by approximately 0.15 percentage points.
3. All eyes on services inflation
While it is anticipated that headline inflation will be slightly lower than the Bank of England’s (BoE) expectations, I identify potential upward risks to the Bank’s already robust forecast for services inflation. The BoE projects a month-on-month increase of approximately 1.4% in services prices, which would mark the highest rise since April 2011. However, my forecast suggests an even more substantial jump of 1.6% month-on-month, the largest since 1993.
A significant contributing factor to my services inflation forecast is a series of annual price increases linked to inflation. This includes around 10% hikes in vehicle excise duty and sewerage prices, as well as a surge of over 12% in telephone bills.
Additionally, the annual increase in social rents is tied to inflation, but this year, the government imposed a cap of 7% for the year. I anticipate that, coupled with another significant increase in private rental costs, this will drive the rent index up by approximately 1.3% month-on-month. If this materializes, it will push services inflation to 7% year-on-year, marking the first time since 1992.
Although the momentum in core goods inflation appears to have softened in April, my robust forecast for services inflation still leads us to project an overall core inflation rate of 6.4% year-on-year, notably higher than the Bloomberg consensus of 6.2%.
Detailed TDS vs BoE forecasts (April)
Source: Haver, TD Securities
Energy contribution is set to drop due to base effects
Source: Haver, TD Securities
Risks around my call
My forecast for headline inflation, without rounding, stands at 8.28% year-on-year. Therefore, I perceive the risks to be tilted more towards the consensus rather than the BoE’s forecast. One contributing factor to this view is my expectation for food and non-alcoholic beverage inflation to be at a modest 0.3% month-on-month, which is significantly lower than the BoE’s forecast of +1.1% month-on-month (refer to the chart above).
Implications for the MPC
The division within the Monetary Policy Committee (MPC) emphasizes the crucial role of data in shaping the monetary policy outlook. While a headline inflation figures lower than the MPC’s May forecast would be welcomed by policymakers, the MPC has explicitly stated that it is the presence of “more persistent [inflation] pressures” that will determine the necessity for further policy tightening. Therefore, a robust core inflation reading, especially if driven by a stronger-than-anticipated increase in services prices, will exert additional pressure on the MPC to raise the Bank Rate by another 25 basis points at its June meeting, even if headline inflation falls short of its forecast.
Currently, market expectations reflect approximately 21 basis points of rate hikes for the upcoming June meeting. Terminal pricing remains high, approaching the 5% threshold. Recent price movements indicate that the short-term end of the yield curve is appropriately priced for a potentially more hawkish stance from the Monetary Policy Committee (MPC). Taking a broader perspective, as the base effects ease, any progress in inflation will likely be perceived as a positive development by the MPC.
Nevertheless, I’m skeptical that the Consumer Price Index (CPI) reading alone would significantly alter market expectations for the June policy hike. The strength observed in core inflation should still validate the anticipated rate increase in June.
Looking ahead to August, MPC pricing could be more susceptible to both downside and upside surprises.