UK: Inflation remains low

UK CPI inflation increased to 0.3% y/y in January 2016 from 0.2% y/y in December 2015 (Danske Bank: 0.4% y/y, consensus: 0.3% y/y). Core inflation declined to 1.2% in January from 1.4% y/y in December. Both CPI inflation and CPI core inflation are expected to remain subdued in 2016 due to a combination of the past appreciation of GBP and the low commodity prices.

The small increase in headline inflation in January was mainly due to ‘Energy’ and ‘Food, Alcoholic Beverages and Tobacco’ which pushed up CPI inflation by 0.14pp and 0.08pp, respectively. This is mainly due to base effects as the drop in commodity prices from the end of 2014 has fallen out of the inflation prints. ‘Clothing and Footwear goods’ and ‘Miscellaneous goods’ pushed CPI inflation up by 0.04pp and 0.03pp, respectively.

The main negative contributor were air fares, which declined 35.8% m/m in January after the large increase of 46.0% m/m in December. This component alone pushed down overall inflation by 0.20pp (and core inflation by 0.27pp).

Although the negative contributions from the ‘Non-energy industrial goods’, ‘Food, Alcoholic beverages and Tobacco’ and ‘Energy’ all declined in January, ‘Services’ remain the only factor that is contributing positively to headline inflation. Services inflation, which to a larger extent is domestically generated, was only 2.3% y/y in January, only slightly above the 2% target. Deflation in other components implies that overall inflation remains low.

The Bank of England has made it clear that it is definitely not ‘Fed light’ and that it is in no hurry to hike rates. There are many reasons for the BoE to stay on hold for a long time: inflation and wage growth are both subdued, inflation expectations have fallen, other central banks (most importantly the ECB) are on an easing bias and Brexit uncertainties loom.

Watch out for the labour market report for December, which is due out tomorrow. We expect the unemployment rate (3M) to have fallen to 5.0% from 5.1% while growth in average weekly earnings excluding bonuses (3M) increased to 1.9% y/y from 1.8%. The labour market is one of the few bright spots left in the BoE’s chart book. Although employment has risen significantly, the BoE still thinks there is some slack left. The BoE argues that long-term unemployment is still elevated and many part-time workers are not able to find full-time work.