King Is Right – UK Inflation Will Hit 4.9% In September

• According to the Bank of England’s Inflation Report, CPI inflation is on track to hit 5% y/y and remain higher than the bank’s 2% target in 2012. Our model confirms this forecast. We expect CPI inflation to hit 4.9% in September, be above 4% throughout the year, and stay above 3% until mid-2012 before dropping towards 2% by spring 2013. Risk to the end-forecast is however skewed to the downside.
• Even though a further rise in inflation clearly is uncomfortable for the BoE, we don’t think it will lead to rate hikes as the economy remains too weak, see Ten good reasons why the Bank of England will keep rates unchanged in 2011. UK rates could, however, rise in panic in the meantime before falling back as it becomes clear that the MPC will keep rates at a record-low for longer than generally perceived.
• Our projection is that data next week will show CPI rose 0.6% m/m in April, leaving the annual pace unchanged at 4.0% y/y. CPI usually rises 0.4% m/m in April.
• Due to higher energy prices, transport (7) is still the component adding mostly to the annual rise in CPI, but food & non-alcoholic beverages (1) and housing & household services (4) are also adding to price pressures.
• The Office for National Statistics has estimated that the budgetary measures that come into force in 2011/12 will add 0.29 percentage points to the CPI

Allocation of items to UK CPI divisions

1. Food & non-alcoholic beverages 
2. Alcohol & tobacco
3. Clothing & footwear 
4. Housing & household services 
5. Furniture & household goods 
6. Health 
7. Transport 
8. Communication 
9. Recreation & culture 
10. Education 
11. Restaurants and hotels 
12. Miscellaneous goods &services

Our CPI approach

Our CPI model is constructed from two main inputs: (1) the current weighted price trend in the 12 CPI sub-groups relative to long-term averages, and (2) the seasonal pattern in each CPI subgroup. The underlying assumption is that the CPI index will return to its long-term trend over a twoyear horizon but be affected by seasonal changes within this period.