Put your pen down Governor...5 takeaways from October's inflation data

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Consumer price inflation, against expectations remained steady at 3% in October, below the level needed for an explanatory letter to the Chancellor. Here are the 5 things you need to know from today’s release.

1) CPI remains steady at 3%

October’s consumer price inflation was unmoved at 3% in October, remaining at its highest level since April 2012. Meanwhile core inflation, which excludes volatile items such as energy, food, alcohol and tobacco was also unmoved at 2.7%. While this does not provide any respite for squeezed households, it is better than expected, with most economists forecasting a rise in inflation to between 3.1%-3.2%.

 

2) What’s behind inflation being at its highest level in 5 years?

Put simply, the weak exchange rate. Following the EU Referendum, sterling depreciated heavily, and still remains 10% below its pre Referendum level. This has led to higher import inflation, which has been steadily filtering through to consumers over the past 6 months. Domestically generated inflation on the other hand, which is heavily influenced by wages (which have been subdued rising by just 2.2% in the three months to August) has been weak.

As a result the rise in prices is almost entirely down to the post-referendum weakness in sterling. That said, recent rallies in the oil price, notably earlier this month when the oil price rose to a two year high of $62/barrel will be an important factor when it comes to the future path of inflation.

 

Sterling-depreciation 

3) What were the biggest contributors to this month’s inflation?

Food and drink, and transport (fuels) were the main drivers keeping inflation at its elevated levels.

Prices of food and drink were up a hefty 4% compared to the same month a year ago, contributing 0.58pp to the overall 3% rise in inflation. This is a noticeable shift from a year ago when food and drink actually pulled the cost of living down (contribution is below zero in chart). The swing can be partially explained by the fact that this time last year food prices were down 2.4%, as the tail end of the supermarket price wars came to an end. Yet as an import intensive sector, the sterling depreciation is also likely to be impacting on prices in the sector, with data from the ONS pointing to the fact that sectors with a greater import intensity continue to make the greatest contribution to CPI level. This will be a concern for squeezed households, given everyone needs to eat…

Elsewhere transport, while price increases eased a bit from 4.2% to 4.0%, was the second largest contributor (0.63pp) to inflation. As mentioned before, further rises are not out of the question in the coming months depending on commodity prices.

Food-and-drink-contribution-to-inflation 

4) What about manufacturers?

While consumers continue to be squeezed, the pass through in the sterling depreciation appears to be moderating for manufacturers, boosting their margins in the process.

In the 12 months to October, manufacturers input prices were up 4.6%, well below the 5 year high recorded in January of 20%. While output price increases did ease back slightly to 2.7%, margins are under considerably less pressure than compared to the start of the year. This supports our latest Manufacturing Outlook which suggests that manufacturers’ margins on domestic sales are in a recovery mode, with inflationary pressures through the supply chain moderating. As a result, now may be the time to start investing in greater levels of process innovation.

Margin-presures-easing 

5) So what does all this mean?

Today’s release does come as a bit of a surprise, and it does beg the question whether inflation has now reached its peak. This month’s figure of 3%, would suggest that the upward pressure is beginning to abate, with the effect of the sterling depreciation becoming exhausted. This will have come as a dovish surprise to the Bank of England. That said the future path of monetary policy will not be dictated by one data point, and there are a number of factors at play which will impact on the future path of inflation and interest rate setting – namely wage growth, which the Bank expects to improve in 2018.

 

ICYMI: On Monday EEF published an infographic and a new report in partnership with Santander – Process innovation: Bringing manufacturers to the frontier. You can read the key highlights in Hela's blog here.

 

 

Author

Economist

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