18th October 2016
Inflation rose to 1 per cent in September from 0.6% in August according to the Office for National Statistics. Experts agree unanimously that the fall in the value of the pound following the vote to leave the European Union is likely to drive prices up, yet beyond that they see many different scenarios.
For now at least the Governor of the Bank of England Mark Carney says the Bank may tolerate an overshoot over concerns that unemployment could spike.
Shilen Shah, bond strategist at Investec Wealth & Investment says: “The September inflation print is a confirmation that the long period of low inflation is over, with year-on-year CPI increasing to 1% from 0.6% in August. The combination of higher input prices -rising 7.2% in September and a higher oil price is likely to put some upward pressure on future inflation prints in the coming months. Governor Carney’s comments last week are however a confirmation that the BoE will not react to the data, as it continues to view the currency’s fall as a shock absorber to the uncertainty created by the Brexit vote.”
Others say the impact of Brexit is just beginning to work its way through the economy though they add that the rise it is not entirely currency related.
Adrian Lowcock, investment director, Architas says: “The jump in inflation in September is largely due to seasonal changes and a rebound from weaker prices in August. Rising oil prices were offset by larger falls in airline fares, while a rise in clothing was driven by seasonal factors. Likewise hotel price rises were down to weakness in prices in August. Clearly the effect of the Brexit result is just beginning to work its way through the economy.”
“However, inflation does look set to return. We are already seeing consumer goods and food producers trying to raise prices and a weak pound is also likely to drive energy and oil prices higher. We would expect the pound to remain weak as Brexit uncertainty weighs on markets, but the difficulty is knowing to what extent rising prices are passed onto customers and therefore how much inflation we will actually see.”
Ben Brettell, Senior Economist, Hargreaves Lansdown notes the economists had predicted a smaller rise.
“UK consumer price inflation jumped to a 22-month high of 1% in September, from 0.6% the previous month. Economists had predicted a smaller increase to 0.8%. The obvious explanation is that the effects of a weak pound are starting to come through more forcefully. Yet the biggest contributor to the rise in CPI inflation was clothing, and in its report the ONS raises some doubts over whether price increases in this sector were related to exchange rate movements.
“Nevertheless inflation looks certain to rise further over the coming months, and could easily exceed the 2% target in 2017. This will undoubtedly be tough on those with low incomes, and it’s also not good news for savers who are losing money in real terms.”
“However we need to remember that sterling’s drop, assuming it doesn’t continue to plummet, is a one-off factor, which will fall out of the year-on-year calculation in twelve months’ time. Mark Carney indicated last week that the MPC would ‘look through’ what should be a temporary bout of inflation and keep monetary policy loose to support the economy. In the aftermath of the financial crisis the Bank of England was prepared to tolerate a spike in inflation to more than 5% while leaving rates at rock bottom.
Brettell says that the bigger picture is that structurally there are very few inflationary pressures – due in part to demographic reasons. “The baby boomers are starting to retire in their droves. They have already gone through their consumption phase – they have bought their houses, cars and consumer goods. The generation behind them is saddled with debt and struggling to get on the housing ladder. There is also no sign of any tightness in the labour market, with wage growth seemingly set to remain depressed. All this should mean less inflationary pressure, lacklustre economic growth, and little upward pressure on interest rates,” he says.
Russ Mould, investment director at AJ Bell says: “Too much inflation could encourage the Bank of England to raise interest rates so consumers would be hit by a double whammy of rising prices and higher borrowing costs.
“The yield on the 10-year Gilt is already back above 1.0%, way higher than its summer lows near 0.5%, and this could start to affect interest rates on debt across the board, from mortgages to corporate bonds, making borrowing more expensive, whether the Bank of England likes it or not.
“From an investment perspective, history shows that a bit of inflation is not a bad thing for stock markets and certainly better than deflation or stagflation. However, if too much inflation causes the Bank of England to raise interest rates or drives Government bond yields higher then investors could be lured away from stocks and back toward cash or bonds, removing some of the support given to share prices by the premium yield that is currently available from equities.”
Currency experts are circumspect about where we go from here with the possibility that plans for a hard Brexit may actually be softening.
Andy Scott, economist at HiFX says: “Sterling had one its best days in recent weeks against the Dollar and the Euro, rising by around three quarters of one percentage point in anticipation of a faster pace of inflation. Those betting on a strong number were right as consumer prices rose 1% versus a year previous, the fastest pace since November 2014 and above consensus market forecasts.
“Sterling’s gains however may prove limited for two reasons. Firstly, if a large input to higher prices is from Sterling’s fall, this won’t impact the Bank of England’s monetary policy decision making process and they could still opt to cut rates if they deem it beneficial and or necessary to support the economy. This latest data wasn’t attributed to a weaker Pound but we anticipate that future pressure will be.
“The second reason, and the more prevalent among investors and traders alike is Brexit. In particular, the domestic political tensions we’re starting to see build within the government over what the stance should be and how this will impact the future relationship with the EU. There are signs that a pragmatism is starting to take hold in the debate over Brexit in the UK, which if matched by the other 27 EU member states could see a relatively positive outcome. However there are still a number of leave voters who want all ties cut and will no doubt make plenty of noise to that effect.”
“With the market having started factoring in a “hard Brexit”, there is plenty of scope for Sterling to recover in the months ahead if the tone of Brexit discussions become more amicable and positive. Alongside this, the economy have proven robust so far and at some point this will start to impact the value of Sterling again.”