Tentative signs of Inflation in the UK?

by George Hatjoullis

Asset prices often give early signs of changing economic conditions. In the parlance of economics they are leading indicators, which is why markets often seem irrational to the layperson. I was checking the likely maturity value of an index linked bond when I noticed the current price seemed to be implying much higher inflation between now and maturity than I was expecting. Maturity is in less than two years so this was a red flag and I checked the RPI data (which is the indexing factor) and the CPI data (which is the official inflation index). Inflation does seem to have perked up. Moreover, there is reason to believe the impulse is not over.The CPI 12 month inflation rate (chart 1) has indeed perked up.

Chart 1

CPI March 2106

The rate of acceleration is also quite sharp. It is around 5%, which is to say that if the index increases by the March amount each month for the next 12 months then the rate of inflation will be around 5%. It is unlikely that such a pace will be sustained but nevertheless it signals something may have changed. The last observation is for March 2016 and thus is unlikely to fully reflect the recent rise in petrol prices or weakness in sterling. There is still potential inflation in the system to manifest.

How far can this go? Obviously impossible to say but the index linked market seems to think the acceleration may significant in the next two years. It certainly seems possible that the period of disinflation/deflation in the UK has ended and that an upward correction is in progress. The BoE will be monitoring very carefully and may change their language which would itself reinforce market optimism (on inflation). The next CPI observation has, for me, taken on a new significance as has the next BoE inflation report. Heads up!

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