As the CPI rate slows to the Bank of England's official target, Rebecca Jones asks what we can expect next.
Jason Hollands, MD – business development, Bestinvest
We expect a relatively benign environment for official UK inflation. While key contributors to the most recent decline included the discounting of food and
non-alcoholic beverages, downward pressure on inflation has actually been
a global phenomenon.
Falling energy prices and a weak outlook for global raw materials have largely driven inflation down, as the slowdown in China’s growth story reverberates around the world. Growing inventory levels of industrial metals suggests a further decline in demand may be in the pipeline. Those factors should keep the lid on manufacturing costs and help keep inflation in check.
Inflation finally in line with the Bank of England’s 2% target eases some of the recent pressure on it to raise interest rates, a move that would carry material risks for the UK given soaring levels of household debt and the extent to which so much of current policy is centred on measures to fuel the residential property market.
And therein lies the dilemma: while price inflation remains low, ultra-low interest rates and other accommodative policies are fuelling asset price inflation and stoking fears of a property bubble.
How sustainable is UK inflation?
Policymakers speak of the virtues of austerity and the need to live within the country’s means at the governmental level, while the impact of policy initiatives is to encourage spending and borrowing at the personal level. For investors, the apparent taming of inflation means a narrowing of bond yields again. That will continue to force them further up the risk-spectrum in the search for income.
Gary Reynolds, CIO, Courtiers, Wealth Management
Global pressure is pushing prices downwards, not upwards. Accordingly, if there is to be any concern over the immediate term inflation target, then it is more likely that it will undershoot its range in the UK than overshoot it.
Inflation may now be on target at 2% per annum but it is much lower elsewhere: 1.4% in Germany, 0.7% in France, 0.7% in Italy and 1.5% in the US.
Despite Abenomics in Japan and massive quantitative easing that has trashed the value of the yen, the Japanese economy can barely muster 1.5% inflation, which is still 0.5% below the Japanese government’s target.
Unemployment is still high throughout the world and that means there is ample scope for increasing supply to meet any immediate increase in demand. It is only when supply cannot be increased to meet demand that inflation will begin to bite.
The global economy is struggling to increase demand as world savings are rising to record levels (the IMF estimates global savings at 25% of GDP in 2013, rising to 27% in 2018). Bearing in mind that savings can be regarded as “less spending”, this is deflationary, not inflationary.
Relatively low levels of inflation throughout the world are good for bond holders as it makes it highly unlikely that interest rates will be rising any time soon.
Nevertheless, they will eventually return to “normal” levels (about 4% per year
in the UK) and this will happen at the long end of the yield curve before the short end starts to move. Accordingly, the yield curve is likely to get steeper, which favours short duration.
Steven Bell,Economist, F&C Investments
UK inflation is bang on the Bank of England’s 2% target for the first time since 2009, ending the worst run of failure since the Bank was given full independence in 1997.
There are good reasons to expect inflation to stay low for the next six months. Wage inflation is low, sterling strength means import costs have fallen and the government plans to limit energy price rises from 2015.
However, the longer-term outlook is not so rosy. Unemployment, which has kept wage inflation down, is falling fast – from 8.1% in July to 7.4% in October. When figures for this month are released in the spring, they are likely to show that the rate has fallen below 7%.
There are good reasons to expect UK growth to remain strong this year, so unemployment should continue to decline. With a fair wind, it could be as low as 6% by the end of the year. This would start to put upward pressure on wages and prices – inflation would then start rising.
Despite above-target inflation, the Bank of England has kept interest rates low for good reasons: the economy was weak and, crucially, wages were growing slower than prices. However, once signs emerge that wages are accelerating, it will revert to raising interest rates to head off higher inflation.
The period of record low interest rates is not quite over but the market is already pricing in a rise at the end of the year. While this would reflect the end of a miserable recession, those who have become used to ever lower mortgage rates should be warned: the tide is beginning to turn.
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