UK Inflation Offers Path for Pause

Summary

• June UK inflation missed versus expectations, across core and headline readings.
• However, momentum remains relatively strong across most of the sectors. The BoE should not read too much into a single month’s positivity.
• Services inflation, while higher than the BoE’s estimate, continues to add to our conclusion that wages are not the main driver of cost pressures, and that the BoE will not need to hike to where the market is pricing.

Market Implications

• This adds to our conviction post-labour market release that there is value fading BoE hikes vs Fed, and being short GBP and long short-end gilts.

A Broad-Based Problem for the BoE

Inflation Meets MPR Forecasts

Headline (+.7.9% YoY) and core (+6.9% YoY) missed consensus expectations by 0.3 and 0.2ppt respectively.

As a result, the BoE’s headline expectations are now looking more realistic – having previously appeared quite stale (Chart 1). The gap between actual and MPR monthly forecasts widened has now narrowed to almost nothing. Core is a little more tricky – the miss vs expectation there was a positive for the BoE, but the trajectory is still far from dovish.

Core Momentum Drops to Typical

The +0.16% MoM core reading was the lowest since January’s surprise drop. It came out about where the typical June MoM would have been pre-inflationary spike (Chart 2). This is a very positive outturn for the BoE, and aligns with our expectation that they will not need to hike so far as market pricing. HOWEVER, as the experience from January showed, a single positive month does not define the trajectory. As such, this alone will probably not convince the BoE that they can pause just yet.

Inflation Beats More Widespread

The breadth of inflation declined on the month, but remains strong vs historic. 8 out of 12 sectors beating their typical monthly rate in the month. While this is the lowest level since January, this remains concerning. Much of the undershoot MoM came in Transport, while Furniture prices remained stable (Chart 3). One slightly concerning factor is the lack of discounting seen in clothing yet – typical Junes see 1.2% MoM declines, while in 2023 we saw a +0.2% rise. July is typically the biggest discounting month for the sector, so there is time for this effect to be seen, but it does still suggest a lack of normalcy in the sector.

Services Strong on Base Effects

Services inflation continued to beat  BoE expectations (Char4). However, this is not a significant difference from the previous month (given the base-effects playing such a strong role). The MoM rate (+0.5%) was pretty strong still, but dropped to its lowest rate since January (when it was sharply negative). The rate was strongly supported by rise in insurance and communications inflation, although hotels appear to have seen a paring (Chart 4).

Services Disinflation Getting More Widespread

Last month it was rising airline fares supporting the YoY services inflation rate, the month before it was water utilities, rent and communications. In June it was insurance (Chart 5). However, positivity should be taken from the fact that these all fall into the least wage intensive bracket. Sectors within maintenance/repair and the most wage intensive sectors continue to see sharp declines in the YoY rate, with hotels leading the decline in June.

As we have consistently noted, while services YoY inflation has been relatively stable recently, the pattern has been one of disinflation in wage-intensive sectors, while the idiosyncratic sectors unrelated to wages have driven the surge.

The BoE should look through this. The logic stands that inflation in sectors such as rent (which is actually a sign of policy transmission), communications (a mathematical result of past year’s inflation) and insurance (again, based on cost of financing) are not suggestive of wage cost pressures or overheating demand.

Together this supports our belief that the BoE can afford to take its foot of the accelerator. We warn that its ability to do so may be limited by it having been bitten in the past, but the underlying story for disinflation is now much stronger than it was in January.

As per Richard’s piece recently, we see good value in being short GBP and long short-end rates.

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

Photo Credit: depositphotos.com

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