Inflation: what the economists say

James Knightley at ING This is the 10th consecutive month of 3%+ consumer price inflation and as such it is unsurprising to hear some members worry about the credibility of the inflation target. A letter of explanation from Bank of England governor King will shortly be published and in it he will no doubt highlight the VAT hike (excluding indirect taxes – CPIY – inflation is just 1.6%), lagged effects of sterling weakness and higher petrol prices. He will also state he believes that inflation will fall back – the Bank forecast CPI at 1.6% in 2 years' time in last week's inflation report. However, given the stronger tone to recent activity data there is little prospect of any policy changes over the next 3-6 months. That said, we still feel that there is a good chance of further quantitative easing at some point next year as fiscal austerity, ongoing credit constraints, deleveraging and negative real wage growth weigh on activity and dampen the inflation threat. Chris Williamson, Markit Irrespective of whether the increase was driven by external factors outside of the Bank of England's control, with soaring fuel prices a key factor behind the latest upturn, the increase gives added weight to the view that the Bank should tighten policy to avoid losing control of inflation expectations. However, the debate among the monetary policy committee (MPC) will remain lively, as any such increase poses a real risk of stifling the fragile recovery in domestic demand. Some easing in price pressures looks likely as competition among retailers intensifies in the lead up to Christmas, but this will no doubt be only a temporary relief. January's VAT rise will push the overall rate of inflation up again, meaning Mervin King will need to keep his pen close to hand for some time as he looks likely to need to write several more letters over the coming year, explaining why inflation remains above target. Samuel Tombs, Capital Economics October's UK CPI figures show that inflationary pressures are building again and will trigger another open letter from Mervyn King – the fourth this year – to the chancellor. The rise in CPI inflation from 3.1% to 3.2% primarily reflected higher petrol prices, which added about 0.1% to CPI inflation. Nonetheless, there are some encouraging signs that price pressures remain contained in other parts of the economy. Food price inflation fell from 4.9% to 4.2%, despite recent trends in imported food prices. Core inflation held steady at 2.7%, perhaps suggesting that retailers are struggling to pass large price rises on to consumers ahead of the VAT hike in January. Admittedly, with inflation for now still high and rising, today's figures are another sign suggesting that the MPC may have to wait a few more months before restarting quantitative easing (QE). But with the recovery set to fade and medium-term price pressures still relatively subdued, we still think that the MPC will sanction more QE in the first half of next year. Howard Archer, IHS Global Insight Mr King had better keep his pen out as he is likely to have write more letters in 2011. Consumer price inflation looks likely to head back up towards 3.5% over the next few months due to higher food, commodity and energy prices. Utility prices are rising, with British Gas to raise its gas and electricity prices by 7% in December. Furthermore, VAT will rise from 17.5% to 20% in January, although this may not actually push the annual inflation rate up given that there was also a VAT hike in January 2010 (back up to 17.5% from 15%). Consumer price inflation will hopefully finally move below 3.0% in the second half of 2011 as the temporary upward impact from higher energy, commodity and food prices, and sterling's past sharp depreciation wanes. Meanwhile, underlying inflationary pressures should be limited by appreciable excess capacity, muted growth overall, strong competition on the high street, and high unemployment. Inflation will hopefully dip below 2.0% early in 2012 as the impact of the January 2011 VAT hikes drops out. The Bank of England will be far from happy with the October consumer price inflation data, but it is essentially in line with the projections contained in the bank's November Quarterly Inflation Report and is unlikely to prompt a near-term interest rate hike. However, the data are likely to reinforce the Bank of England's reluctance to re-engage in quantitative easing for now at least. We still expect the Bank of England to keep interest rates down at 0.5% deep into 2011. This reflects our belief that the growth will slow appreciably in the first half of 2011, although we do expect a double dip to be avoided. Specifically, we forecast the first interest rate hike to come in the fourth quarter of 2011 and see interest rates still only at 0.75% at the end of next year. Furthermore, we would not rule out interest rates staying down at 0.50% until 2012. And whenever interest rates do finally start to rise, they are likely to increase only gradually and remain very low compared to past norms, as monetary policy will need to remain loose for an extended period to offset the impact of the major, sustained fiscal squeeze. Meanwhile, further quantitative easing in the first half of 2011 remains very much a possibility should the economy slow markedly.