Inflation Surprises To The Downside, Relative To Expectations

Despite positive momentum in the inflationary environment, UK CPI increased less than expected in January at 1.8% vs 1.9% expected. Relative to expectation, the downside surprise from this month’s reading helps normalize the recent trend of upside CPI surprises.

The details of the report show that UK transport prices continue to provide support while there are also further signs of food prices continuing to reverse the downward pressure seen over the last year. Food inflation at -0.4% now sits at its highest level since June 2014 and while month over month rises was at a slower pace than December, leading indicators still clearly point to the continued upside.

Although this month’s downside surprise is counter to the stronger upside surprises seen recently, prices are expected to continue to rise over the coming months with input prices, domestic output prices and also selling price indicators pointing to further gains over the coming months.

Retail Sales Highlight Reluctance Among Consumers

Retail sales data for January highlighted reluctance among consumers with total retail sales volumes printing -0.3% month over month. The key element behind the weaker figure in January was non-store retailing which contracts 4.1%, followed by food store retailing and automotive fuel at -0.5% and -1.5% respectively.  Indeed, the BRX Retail Sales Monitor reported that total sales rose only 0.1% year over year in January, which is well below the 3 month average of 1.1% and a one-year average of 0.9%.

December Wage Reading Below Expectations

The December wage reading was also below expectations which were skewed towards 2.7% for the regular pay, which came in at 2.6%. This reading, again, tempers the strength of November’s reading. The 3 and 6-month moving averages for regular private pay, now sit comfortably in line with last year’s average at 2%.  The fact that, for now, inflationary pressures are yet to show signs of clear transmission into wage growth, will be pleasing for the BOE who will not yet have to move on rates. However, looking ahead, rising inflation will create upside risks, with trends in inflation and unemployment consistent with further wage growth.

Referring to the February inflation report, the MPC’s current assessment is premised on three key elements remaining valid.

• 1) Inflation expectations need to remain anchored, and the transmission from Sterling weakness must not become excessive. 2) Following the revision to supply side estimates of spare capacity, regular pay growth needs to remain modest. 3) Consumption needs to show signs of moderating as the real income shock to higher inflation starts to become apparent.

Inflation data last week represents the first test of assumptions 1 and 2 suggesting that for now, these assumptions remain unchallenged. However, leading indicators for price clearly imply continued acceleration of prices, which presents upside risks to wages. For now, the February Inflation Report judgment has passed their first UK data test, meaning the BOE should be comfortable with a current monetary policy for the time-being.

MPC Changes Upcoming

The recent announcement of changes at the BOE further suggests that the BOE will refrain from changing their viewpoint in the near term. Forbes, who is known as one of the more Hawkish members of the MPC, announced that she would be leaving once her term expires on June 30^th. With no replacement announced as of yet, there is a risk that the new member will not be as Hawkish as Forbes which could fuel a repricing ahead of upcoming meetings.

The Technical Landscape

GBP/USD continues to move within a broad bullish channel formed after the post-flash-crash correction. For now, price remains near the top of the channel. Key resistance will be a test of the bearish channel resistance line alongside the February and December highs. Support will be a test of the channel lows, where there is also symmetry confluence, and the January low.