Slow Growth May Limit UK Inflation
On the CPI-based measure, inflation rose from 2.0% in June to 2.3% in July, overshooting the Monetary Policy Committee’s 2% target for the first time in over seven years. Petrol prices played a major role, with benchmark West Texas Intermediate (WTI) recently hitting a nominal all-time high of US$67.10 per barrel. Morgan Stanley has pointed out that WTI in real terms is now more than 25% above the levels of the late 1990’s in the run up to the first Gulf War, and back to levels last seen in late 1982. However, it still remains below the ‘spike’ level of 1979/80 (equivalent to US$80 per barrel at current prices).
Rising oil prices have prompted increases in other fuel costs, with electricity and gas prices rising by 9.4% and 12.8% respectively over the past year. However, even when energy costs are excluded, inflation rose from 1.6% to 1.9%, with the price of all sorts of items rising at rates well in excess of 2.3%. In general, service prices have continued to rise rapidly, whereas goods prices have not. For example, the price of household services has risen by almost 7% but clothes prices have fallen by almost 5%. Indeed, over the last ten years the price of clothing and footwear has declined 40%.
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It is likely that oil prices are destined to rise further and that the CPI might rise above 2.5%. Some commentators have suggested that this may persuade the nine members of the MPC, four of whom voted against the cut in interest rates, to put rates back up. However, in the past, interest rates cycles have not consisted of a single small cut which has then been reversed. The revised Q2 GDP figure is also likely to show economic growth running below trend for the fourth successive quarter. Weak consumer spending data could even persuade the Governor and the other dissenters to vote for further interest rate reductions despite the fact that the inflation rate in the immediate term could be heading higher. This is on the basis that slowing consumer demand will limit price increases through increased competitive pressures, and once the direct impact of higher oil prices falls out of the year on year comparisons, the inflation rate will fall back in line with the Bank of England’s 2% target.
By Edward Menashy, economist at Charles Stanley Equity Researc
