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Inflation: a small taste of things to come - HL comment

Ben Brettell, Senior Economist, Hargreaves Lansdown:

July’s CPI report marks the first piece of hard economic data since the referendum result, and as such will be keenly scrutinised for any clues as to the impact of the Brexit vote.

Perhaps in a taste of things to come, import prices rose 6.5% year-on-year, their fastest rate in five years.

However, in truth the small tick upwards in the headline rate to 0.6% tells us little. The ONS collects data in the middle of each month, so the prices were collected just two or three weeks after the vote. It’s almost certain that the weaker pound will cause inflation to rise more sharply in the coming months, but the effect of sterling’s depreciation will take time to feed through fully into the figures as businesses gradually adjust to the new environment. Over the next few months existing inventories will be wound down and currency hedges put in place by supermarkets and other importers will gradually start to fall out of the equation. It is only then that the full impact will be seen.

July’s figure was also held back by energy and fuel prices. Though prices rose month-on-month, Brent crude was still slightly cheaper in sterling terms this last month than a year earlier, despite the fall in the pound.

Forecasts suggest CPI inflation could ultimately reach 3%. However, this will be a temporary factor, assuming sterling remains weak, the effect will fall out of the year-on-year calculation in the second half of next year.

Underlying inflationary pressure is hard to see, with Brexit-related economic uncertainty likely to dampen both consumer spending and wage growth in the short term. The Bank of England is rightly ignoring what should be a temporary spike in inflation when it sets monetary policy. The Bank is widely expected to leave rates on hold at its next meeting in September, though swap markets are pricing in around a 33% chance of a cut to zero by the end of the year.


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