UK: Volatile airfares lifted inflation pre-Brexit - ING

James Smith, Economist at ING, suggests that although the latest UK inflation data relates to pre-Brexit prices, the 9% drop in sterling post-vote could help push inflation above the Bank of England's target as early as 1Q17.

Key Quotes

“UK inflation came in marginally higher than expected (0.5% YoY vs. 0.4% consensus), partly owing to another volatile month for airfares. Following some big swings around Easter, the price of plane tickets increased by 11%, which has been attributed to the recent Euro 2016 football tournament. Petrol prices also continued their upward trend in June, nudging transport costs up by 1.1% MoM, as the effect of a weaker sterling continued to combine with higher crude oil prices.

The main caveat with this month’s data is that it relates to pre-Brexit prices and therefore assumes less relevance for markets and the Bank of England (the same is true of labour market and retail sales data released later this week). Since the vote on the 23rd June, GBP has fallen by roughly 9% on a trade-weighted basis and this will inevitably translate into higher inflation. That said, the pass-through of exchange rate movements to inflation does not happen overnight; fuel prices for instance are only around 1-1.5% higher since the vote. We therefore shouldn’t expect a kneejerk spike in CPI next month, but the magnitude of sterling’s plunge (around 15% since November 2015) means that inflation is likely to break above the Bank of England’s (BoE) 2% target, perhaps as early as the first quarter of 2017.

In any case, we think that the BoE will largely “look through” this short-term inflationary spike and focus instead on the medium-term downside risks posed by weaker domestic demand and a higher output gap. Next month, we think that the MPC will cut rates by 25bp and boost QE by an initial sum of £50bn, potentially followed by further easing in the autumn.”