No surprises on the inflation front

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Today’s report on UK consumer prices in February provided no surprises, with inflation remaining subdued. The annual rate rose 0.3%, the same as in January and the fourth consecutive monthly increase.

The main contributions came from higher prices for food, restaurants & hotels, and furniture. While the prices of food such as fruit and vegetables are typically volatile, the contributions from restaurants & hotels and furniture suggest that the UK’s healthy labour market continues to support domestic demand. In contrast, the main drag was from the transport sector. The price of Brent crude oil - the European benchmark - in February was well below its level in the same month of 2015, pushing down the cost of transport.

Domestic and export prices still weak

Our latest Manufacturing Outlook tells a similar story, with selling prices remaining weak in the three months to March. The balances for both domestic and export prices were negative for the seventh consecutive quarter (a negative balance indicates that the percentage of manufacturers reporting their prices as lower was greater than those saying they were higher). The weak selling prices indicate that manufacturers are passing on the lower input costs they have faced from the collapse in the prices of global commodities such as oil over the last year or so.


Profit margins are also under pressure, with the balances for both domestic and export margins negative for the eighth quarter in a row. The balance for domestic margins fell deeper into negative territory, possibly due to factors including the recent weakening of Sterling boosting the cost of imported inputs. Sterling has depreciated by around 10% against both the US dollar and the euro since the middle of last year.

In contrast, the balance for export margins was up from the final quarter of last year and higher than that for domestic margins for the first time since 2013. The small improvement could be due to the weaker Sterling improving the competitiveness of UK exports, and stronger economic growth in key trading partners. At the same time, it’s possible that the squeeze on domestic and export margins is coming from fixed costs or overhead.

The weakness of profit margins does not bode well for business investment as it makes it harder for companies to internally fund capital expenditure. The Manufacturing Outlook showed that the balance for capital expenditure planned in the next 12 months was negative for the second quarter in a row.


Inflation has likely bottomed out

Looking ahead, our Manufacturing Outlook indicates that the downward pressure on prices should ease somewhat in the next three months. At the same time, there are signs that cost-push pressures have started to recover. In particular, the Brent oil price appears to have stabilized, gradually rising to a three-month high of US$41 per barrel currently. Also, our survey indicates that margins are expected to improve in the next three months.

Inflation is likely to rise this year after coming in at 0% in 2015, the lowest rate since 1960. Our forecast is for the inflation rate to increase 0.3% on an annual average basis this year before climbing to 1.3% in 2017, still well below the Bank of England’s target of 2%.



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