UK inflation falls short of expectations - ING

Research Team at ING, notes that the UK inflation came in at 0.3% YoY, below market expectations although in line with the latest Bank of England forecast and thus should not come as much of a surprise to policymakers.

Key Quotes

“Digging beneath the surface, air fares reversed their 23% MoM increase in March and fell 14% in April, a temporary effect resulting from the earlier timing of Easter this year. Other temporary factors included the lagged effect of utility price cuts, with gas prices down by 4.6% since January, which was offset by a 1.8%MoM increase in the price of Tobacco following the introduction of higher duties during April.

Interestingly, food prices fell again (albeit only marginally) on the month, although tentative signs that the supermarket price war (which has driven down prices by 6.2% since early 2014) is become less intense, combined with a weaker sterling, should mean that the food component is less of a drag on headline inflation over coming months.

Although April’s inflation data fell short of market expectations, it is worth noting that it is in line with the forecast provided by the Bank of England in its latest inflation report and thus should not come as much of a surprise to policymakers. Indeed, in light of the forthcoming EU referendum, the focus is now more on the activity data than prices.

In that regard, Thursday’s retail sales data and more importantly, tomorrow’s labour market report will be key. Tomorrow, there is a risk that we see total unemployment rise and employment fall, with a slowdown in wage growth, which would suggest that the uncertainty surrounding the referendum outcome is prompting firms to hold off on investment/hiring until the result becomes clearer.

If the UK votes to remain in the EU, then we expect the next move from the BoE to be a hike, although the timing of this depends on how quick any post-referendum activity rebound takes to materialise. We feel that there may be some lag involved and as we discussed in our Monthly Economic Update last week, expect the first move to come in the first quarter of 2017. If the UK votes to leave the EU, then we think the BoE may choose to cut rates to shore up confidence, even though the likely plunge in sterling may add to medium-term inflation pressures.

FX Implications:

Sterling faces a difficult week ahead, with the UK labour report expected to accelerate concerns over a slowdown in the domestic economy. A resurgent USD, coupled with waning support from the global risk environment and the renewal of Brexit risks, means that a sharp fall in GBP/USD may be on the cards. Look for the 50/100-dma support to give way, with scope for a move to 1.4100/50 (s/t fair value).”