Schroders Quickview: Falling UK inflation to spur domestic demand
Schroders Research Analyst Charlotte Morrish sees falling inflation as a positive for UK domestic demand as consumers reap the rewards of falling energy costs.
24 March 2015
The UK Consumer Price Index (CPI) came in at 0.0% in February, lower than expectations for +0.1%, which represents the lowest level of inflation on record.
The recent decline in inflation should be positive for domestic demand (consumer spending and business investment) and serve to prolong the UK’s business cycle.
If end demand remains positive, then falling prices should not feed through into wage negotiations; the current low rate of inflation is likely to be temporary.
In the short-term this means that the UK’s interest rate trajectory is more likely to be driven by labour market data than movements in the headline inflation rate.
Our expectations for continued growth in the UK economy and a (long-awaited) corresponding pickup in wage growth are unchanged.
Cheaper food and petrol fuelling inflation fall
The major cause for the fall in the headline rate has been well-documented.
The Office for National Statistics estimates that 0.9% of the decline relative to February 2014 (+1.7%) can be attributed to declining food and petrol prices.
Core CPI inflation (which excludes food and energy) was a more steady +1.2%.
Prices in a number of consumer services segments, such as restaurants & hotels and education, increased at similar rates to a year ago, suggesting that consumer demand in the UK remains stable.
The fall in energy prices over the last six months has been largely driven by an increase in global supply rather than a fall in global end demand.
Producer prices showed substantial declines in input prices (-13.5%) and more mild fall in output prices (-1.8%), which should serve to support company margins as well as the outlook for the labour market.
House price inflation remained robust at +8.4%.
Supply not demand falling
Taken together, we are inclined to agree with the Bank of England’s analysis in February’s Inflation Report that the fall in energy prices over the last six months has been largely driven by an increase in global supply rather than a fall in global end demand.
This supports our view that the decline in inflation is a net positive for domestic demand.
Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.