CPI inflation was unchanged from February, increasing by 2.3% in the year to March 2017. Rising food and clothing prices were the main culprits behind the inflationary pressures, but those were largely offset by downward contributions from air fares and motor fuels.
Manufacturers also saw input cost pressures ease somewhat in March. Input prices rose by 17.9% on the year, a touch lower than the 19.1% increase in February. Still, that was the 9th consecutive month of input price increases, signalling continued pressure on profit margins.
Apart from making the stuff we buy more expensive, the path of inflation is a significant determinant of monetary policy. Since the Referendum, and the subsequent depreciation in the value of Sterling, economic debate has focused on how monetary policy should react to balance out the risks stemming from Brexit and rising inflation.
So far, the Bank of England (BoE) has judged that above-target inflation is a trade-off the Monetary Policy Committee is willing to tolerate. It’s the price to pay so that loose monetary policy can continue to support job creation and economic activity. But in which direction does today’s inflation data sway the BoE interest rate decision?
1. The mood has changed in the MPC
In the minutes of the March Monetary Policy Committee (MPC) meeting we saw somewhat of a mood change. While the interest rate decision was left unchanged, Kirsten Forbes dissented to break the MPC’s unanimity for the first time since the EU referendum.
What’s more, the minutes indicate that it would take little more upside news on the UK economy for other members to join Kirsten Forbes in considering a reduction in monetary policy support. Forbes cited domestic inflationary pressures, global reflation and little labour market slack, as upside risks to inflation that warrant action on interest rates.
2. But today’s data unlikely to change it further
On the face of it, inflation stalling at 2.3% in March would play in the hands of the more dovish members of the Committee. However, the inflation rate actually came slightly above expectations of a slightly decrease in March.
We expected the drag on air fares from the change in the timing of Easter to more than offset other price increases on CPI. This means we’re likely in for a more considerable spike in the inflation rate next month. Given the increasing number of MPC members adopting a more hawkish stance, there could be more dissent in the May meeting if inflation continues to surprise on the upside.
However, this monthly data point is unlikely to sway the BoE decision either way. Given that the collective judgement of the MPC is that the rise in inflation is temporary and there are downside risks to aggregate demand via a slowdown in consumer spending, we do not expect monetary policy action or too much change in the tone of the May minutes based on today’s inflation release. Of course that could change further out if the inflation rate significantly overshoots the BoE’s projections in the coming months.
3. All eyes on wage inflation
The inflation rate is one of three interrelated indicators the MPC is keeping a close watch on. The other two are wage inflation and the strength of consumer spending. Real wage growth has disappointed so far, with the three month average growth rate falling to 2.2% in January 2017, its lowest rate of increase since April 2016.
In his recent speech, MPC member Gertjan Vlieghe argued that as long as household incomes remain squeezed and earnings growth shows little underlying inflationary pressure, there is no real impetus to raise interest rates any time soon. With some signs that consumer spending is slowing down, an interest hike could harm real economic growth.
With labour market statistics coming out on Wednesday, the MPC’s attention is likely to shift to the earnings data. A large upside surprise, which we think is unlikely, could cause more dissent in the MPC. But even if that materialises, the MPC is likely to wait for more evidence on the continued strength of the UK economy before it pulls the trigger on interest rates.