UK inflation unexpectedly slows – weekly update 24 July

UK inflation and retail sales data provided a surprise

UK inflation and retail sales data provided quite a surprise last week, temporarily bucking an economically-negative trend of increasing inflation and collapsing retail consumption. UK Consumer Prices Index (CPI) inflation unexpectedly slowed to 2.6% year on year (yoy) in June (from 2.9%, no change was forecast). Core CPI, which strips out the most volatile elements such as fuel and food, fell from 2.6% to 2.4% (again, no change was expected).

Fuel prices are slightly lower now than a year ago, meaning a deflationary impact on headline inflation, whilst the recreation and cultural inflation element, affecting both headline and core inflation measures, appears to have been affected by seasonal factors.

A key question is what impact the currency weakness following the Brexit vote is having on inflation. Clearly higher overseas prices are expected to be a source of inflationary pressure, however the timing is much harder to predict as these higher prices trickle through the economy.

Turning to retail sales, the June figures saw a surge from 0.9% to 2.9% yoy, well ahead of forecasts for 2.5%. The main driver appeared to be strong clothing sales as Britain enjoyed (or suffered) the longest heatwave in 20 years. Whilst some have come to the conclusion that these numbers take some of the pressure off the Bank of England, we believe the underlying economic factors for the UK will continue to push inflation up and retail sales down, with these isolated data readings being a statistical blip.

Rolling three-month average UK Retail Sales and CPI inflation (year on year)

No news from the main Central bank meetings

The main Central bank meetings on Thursday ended up adding relatively little to the discourse. The Bank of Japan (BoJ) cut its inflation target for the fiscal year 2017/18 by 0.3% to 1.1% yoy, whilst upgrading its economic growth forecast by 0.2% to 1.8% yoy. There was no change to monetary policy, and the softening inflation forecast suggests that any tightening of policy likely remains some way off, though further stimulus seems highly unlikely.

Over at the European Central Bank (ECB), President Mario Draghi was also not giving much away. The ECB President still talked of the need to keep some level of economic support, but interestingly didn’t take the opportunity to try to talk bond yields and FX back down – prompting the euro to surge over 1% higher versus the US dollar. ECB monetary policy remained unchanged, and no further guidance was provided on any tapering of the quantitative easing programme, pushing expectations for a decision further out into Q3.

Last week’s other events

• The IMF left its forecast for global growth unchanged at 3.5% yoy for 2017 and 3.6% in 2018. The details, however, saw 2017 UK and US growth expectations downgraded (0.3% to 1.7% and 0.2% to 2.1% respectively) whilst the Eurozone was upgraded 0.2% to 1.9%, with China and Japan also upgraded.
• Chinese GDP for the second quarter was unchanged at 6.9% yoy, ahead of forecasts for a dip to 6.8%. Fixed Asset Investment increased 8.6% yoy (year to date, the same as the previous month and ahead of 8.5% expected). Retail Sales growth accelerated to 11.0% yoy (from 10.7%, 10.6% expected) and Industrial Production was also improved at 7.6% yoy (from 6.5% with no change forecast).
• Eurozone Consumer Confidence slipped from -1.3 to -1.7 (-1.1 was expected), and the ZEW Economic Sentiment Index also disappointed, dipping from 37.7 to 35.6 (37.2 expected)
• The US Empire State Manufacturing Index fell from 19.8 to 9.8 (15.0 was expected), and the Philadelphia Fed Manufacturing Index confirmed the downswing, coming in at 19.5 (from 27.6, 24.0 was expected).

The markets

It was a modest week for equities, whilst core sovereign bonds regained some strength on a more benign inflation outlook.

One month performance of major asset classes

Equities

UK equities led major regions with the MSCI United Kingdom index gaining 1.3%, whilst in the US the S&P 500 returned 0.6%. Europe had a tougher week, as the MSCI Europe (ex-UK) shed -1.9%. The Japanese TOPIX was up just 0.3% on the week, whilst the MSCI Emerging Markets index returned 0.9%.

Bonds

Core bond yields fell across most major regions, led by UK gilts where 10-year yields were 13 basis points (bps) lower to finish the week at 1.18%. 10-year US Treasury yields were down 10 bps to 2.24% whilst the equivalent German bunds were 8 bps lower at 0.51%.

Commodities

Oil dipped at the end of the week, with Brent Crude closing at US$48.06 per barrel. Gold was up on the week, finishing at US$1,254.30 per ounce and copper also regained some strength to finish at US$2.72 per lb.

Currencies

Sterling fell quite sharply on the back of weak inflation, falling as much as -2.5% against a stronger euro. Sterling closed Friday at US$1.30, €1.11 and ¥144.

The week ahead

Even as summer holiday season gets into full swing, it’s a busy week on the economic calendar. The US Federal Open Market Committee (FOMC) meeting concludes on Wednesday, although no change is forecast (in fact, markets are pricing in 0.0% chance of a hike, with no hike priced in above 50% until March 2018). Wednesday also has the first estimate of UK Q2 GDP (1.7% yoy forecast, from 2.0% in the first quarter), with Q2 GDP for the US out on Friday (2.5% annualised quarter on quarter expected from 1.4%). There will also be PMI numbers of the Eurozone and US, and US Durable Goods to look out for. The daily breakdown is as follows:

Monday: A busy day for PMI readings, with the Eurozone numbers for Manufacturing (57.2 expected from 57.4) and Services (54.1 expected from 54.2) out in the morning, followed by the US in the afternoon with the Markit readings. US Manufacturing PMI is expected at 52.1 from 52.0, Services PMI is expected at 54.1 from 54.2.

Tuesday: Minutes from the BoJ Monetary Policy Meeting are released early in the morning, followed by German business sentiment surveys from Ifo and UK business sentiment from the CBI before lunch. In the afternoon, US Consumer Confidence data will be out, as well as US Home Prices.

Wednesday: Aside from the headline events of the FOMC meeting and UK Q2 GDP, there is little else in the calendar midweek.

Thursday: US Durable goods are the highlight for Thursday, where a rebound from -1.1% to 3.0% month on month is expected. Thursday will also see German Consumer Confidence, the Chicago Fed National Activity Index, Kansas Fed Manufacturing Index and US Wholesale Inventories data being released.

Friday: It’s also a busy end to the week. A little after midnight, UK Consumer Confidence data is released, followed by data from Japan on Inflation, Unemployment and Retail Sales. Later in the morning we will also have Eurozone Business Confidence reported. In the afternoon, the GDP figure for Q2 will also have the associated data including quarterly PCE price inflation and Employment Costs.