The UK Consumer Price Index (CPI) eased for the third consecutive month bringing inflation down to 10.1% in January, from December’s 10.5% figure.
The figure squeaked in below the 10.3% Bank of England economists had expected. Core inflation, which strips out food and energy, slowed to 5.8% from December’s 6.3% – its lowest in seven months.
However, industry commentators are split over whether the downward direction of travel could lead to a more dovish approach from the BoE after 12 months of interest rate hikes.
Nicholas Hyett, Wealth Club investment analyst, said: “Is inflation still problematically high or is it now coming under control? You could argue for either, or even both, a sign of the confused picture for inflation at present. It won’t make life easier for the policymakers, and raises questions around the future course of interest rates in particular.
“When it comes to interest rates, the financial world divides into the hawks and the doves – those who think rates will rise and those who think rates will fall. Sentiment has swung wildly between the two over the last six months and, since inflation is the key factor determining interest rate movements, these numbers will have been closely watched by both sides. Unfortunately, there’s little in here to calm confusion in the financial aviary.
“For those who think inflation is on a lasting downward trend, and therefore expecting interest rate rises to slow and perhaps reverse later in the year, there’s a welcome fall in headline inflation. That’s driven by movements in transport costs, largely down to lower motor and aviation costs. That trend will continue as we lap the higher fuel costs that followed the Russian invasion of Ukraine last year, and become a major drag on overall inflation in a few months’ time.
“However, more domestically-focused inflation is gathering pace. Areas like health and recreation and culture are starting to see prices tick up, while a tight labour market and strikes across the economy are likely to drive wage costs higher later in the year. Sometimes described as ‘core’ inflation, this can be harder for central bankers to get under control – suggesting higher rates might be needed to bring price rises under control.
“There’s food for hawks and doves alike.”
Sighs of relief
While January’s CPI figures were a small step in the right direction, there is still a long way to go before rate-setters can pause rate hikes, according to JP Morgan Asset Management global market strategist Hugh Gimber. “Today’s UK inflation data will likely be met with sighs of relief in Threadneedle Street that the inflation picture is finally starting to improve.
“The monthly decline in price pressures in services sectors, such as restaurants and hotels, will be particularly encouraging given that these are industries where labour shortages – and therefore wage pressures – have been especially acute.
“Yet, while this morning’s print is a small step in the right direction, the BoE still faces a very long journey to get inflation back to target. Absent a rapid improvement in labour supply, UK activity will need to slow further to reduce underlying inflationary pressures. Yesterday’s jobs data highlighted this clearly, with the 12th consecutive month of stronger than anticipated wage growth providing yet more evidence that the labour market continues to run hot.
“Both investors and policymakers should be wary of reading too much into one month of data. The overall message from this week’s data is that inflationary pressures in the UK economy remain strong, and further rate hikes are necessary. We see interest rates of 4.5% as the minimum required to return inflation to target over the coming quarters.”
Inflation still eye-wateringly high
Despite inflation still running into double-digits, Goldman Sachs global fixed income macro strategist Gurpreet Gill said the direction of travel is encouraging.
She said: “Today’s figures show that, in January, both headline and core inflation continued to move past their October peak. Even accounting for mechanical changes in weights assigned to items in the CPI inflation basket, the direction of travel is encouraging. The contribution to inflation from services is falling, in line with the BoE’s projections.
“The data has arrived the day after a sharp sell-off in sovereign bonds, with the two-year UK gilt yield jumping 0.2% to 3.8%—its highest level since last October, on raised expectations for another rate hike at the BoE’s March meeting.
“We believe the outlook for monetary policy is finely balanced between one further 0.25% rate hike and a pause in rate actions. December’s labour market data, which suggests wage pressures may now be past their peak, combined with a continued moderation in inflation data, favours the case for no further tightening. Yet a tight labour market and bumpy path to disinflation—as observed in the US—could see the [BoE] stay in risk management mode a bit longer.”
Ben Gutteridge, director of model portfolio services at Invesco, added: “Though inflation prints are still eye wateringly high, this morning’s release supports the BoE’s claim that inflationary pressures are moderating. Expectations for a 3% headline rate by year end still appear ambitious, not least given this week’s firm wage data, however, the confluence of weaker commodity prices, goods prices and housing data, suggest inflation could start to fall more rapidly as we move into the summer months.
“The BoE has, of late, been preparing markets for a pause in its interest rate hiking policy and, therefore, will feel vindicated in these efforts based on this latest inflation release. Though another interest rate hike is still anticipated in March, thereafter the bank would most likely keep rates on hold to assess the condition of the economy and inflationary trends.
“Such is the sensitivity of the UK economy to policy rates however, primarily down to the UK’s preference for shorter-term mortgage deals, that as we move through the year economic conditions may look increasingly perilous. By year end, therefore, the BoE may have flipped to an easing interest rate agenda.
“Though such an outcome makes for troubled reading, equity markets are forward looking in nature. This means UK stock markets can still perform well, even in the midst of a recession, as investors begin to anticipate recovery. It is also worth noting that the dominant companies in the UK stock market are global in nature, meaning the performance of the domestic economy has relatively little bearing for equity investors.”
The Monetary Policy Committee will have February’s inflation figures to pore over before the next decision on interest rates on 23 March.