Recent data has shown that inflation in the UK has risen for the first time since February. CPI, where the Bank of England has a target rate of 2%, rose to 1.5% in October from 1.1% in September. The RPI measure also rose in October to -0.8% from -1.4% in September.
The rise in inflation was not unexpected and the Bank of England had already warned that this would take place towards the end of this year while most analysts also predicted that the inflation rate would start to climb.
The main reason behind the sharp rise is that fuel prices fell by a lot less than they did in the same period in 2008. In fact, the Office of National Statistics (ONS) stated that monthly fuel costs fell by just 0.7% in October compared to 6.1% last year. The record fall in 2008 was owing to the sharp decline in the oil price at the time.
Although RPI remains negative, this reflects the significantly lower mortgage interest payments. Furthermore, the rise in RPI in October represented the largest monthly increase since 1990. Part of this rise was owing to house prices that have now started to rise, but were falling this time last year.
The short-term outlook for inflation is expected to be volatile, but the rate is likely to continue rising sharply in the next few months.
There are a number of factors that are likely to push inflation higher and the continued revival in commodity prices and in particular oil is likely to have a major impact owing to higher petrol prices, especially when taking into account the comparative sharp falls in the oil price in the final months of 2008.
The beginning of next year also sees the end of the temporary reduction in VAT as it is due to return to its normal level of 17.5% on 1st January and this could potentially provide further upward pressure on prices. In addition, the overall weakness in sterling in recent times may add to inflationary expectations while food pricing has also been strong of late.
Expectations of rising inflation in the short-term are also reflected in the Bank of England’s latest quarterly inflation outlook as it states that CPI is likely to rise sharply above the 2% target in the near term when taking into account the reversal of last year’s VAT cut and higher petrol prices.
There are also concerns in the market that the rise in inflation in early 2010 will take it above 3%, which is over the threshold that results in the Governor of the Bank of England having to write an open letter of explanation to the Chancellor.
Looking past early 2010, the widely held view is that inflation should subside to an extent, though this does not mean that it will fall either to or below the 2% target level.
However, it is difficult to comment with any certainty on the final destination of inflation for the remainder of next year as much will also depend on the strength of any recovery in the UK economy as well as price pressures such as those already mentioned.
Richard Wallis is head of research and investment at Origen
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