Inflation: two years of temporary factors

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Today's producer prices data reflect what surveys such as the PMI have been pointing to for the last few months: input price rises are starting to ease.

Although prices were still up by over 14% in the year to October, this was the lowest annual increase since December 2010. What is more, between September and October prices actually fell back a little, mainly reflecting price falls in crude oil, imported metals and home produced food.

This will provide some comfort for the Monetary Policy Committee, which has argued that consistently above-target inflation has been largely caused by external pressures that should start to abate in the next twelve months.

Based on this view, the MPC announced yesterday that it would keep the base rate on hold at its record-low level of 0.5% and continue to add to its stock of asset purchases up to a value of £275bn over the next three months. This loose monetary policy also reflects the MPC's belief that demand – at home and abroad – will be so weak as to risk inflation falling below target in the medium term.

But these arguments are disarmingly similar to those we have heard from the MPC from some time. And inflation has remained high. In December inflation will have been above the MPC's target rate of 2% for two years.

Ahead of the Bank's Inflation Report next week, here is a quick overview of what's kept inflation above-target:

Two years of temporary factors

1) VAT
The two increases in VAT, in January 2010 and January 2011, both had a year-long impact on the figure for CPI. This effect will fall out of the figures in January 2012.
VAT has a significant impact on consumer prices
12-month % change in CPI and CPIY (CPI excluding indirect taxes)
Source: ONS, 2011
2) Exchange rate depreciation
Though its impact was less marked this year than in 2010, the depreciation of sterling which started in mid-2007 added significantly to the cost of imported goods, thereby feeding through into consumer prices.
In the past year sterling exchange rates have been much more stable, and though high levels of uncertainty in Europe mean that this could change, there is no particular reason to think that sterling will drop significantly in value, as most commentators now believe the currency is closer to its true value.
3) Commodity price rises
As I have pointed out, pressure on producer prices has started to abate in the last few months. Weaker global demand would point to this trend continuing.
Although previous energy price-rises meant that energy providers have recently passed on big price rises to their customers, even this should work its way out of the inflation statistics by September next year.
Producer prices have stabilised in recent months
Producer Prices Index, Input Prices (2005=100)
Source: ONS, 2011


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