The drop in CPI inflation from 1.8% in January to 1.7% in February is a small sign of things to come – we expect the effects of the coronavirus crisis to drag inflation below 1.0% in the months ahead.
Inflation to drop to 1% in the third quarter
- The drop in CPI inflation from 1.8% in January to 1.7% in February is a small sign of things to come – we expect the effects of the coronavirus crisis to drag inflation below 1.0% in the months ahead.
- The decline in inflation to 1.7% was in line with the consensus forecast, with the largest downward contribution coming from fuel prices. (See Table 1.) The breakdown also showed slight falls in a few other components, including household services, furniture, alcohol and tobacco.
- However, the core rate (which excludes food, alcohol, tobacco and energy) rose a touch, from 1.6% to 1.7%, largely due to a 1.6% m/m rise in the prices for accommodation. Food prices also picked up by 0.2% m/m. But since prices were collected on 18th February, it was probably too early for any shortages as a result of panic buying to show up in the figures.
- Looking ahead, the precipitous drop in global oil prices will quickly feed through to a collapse in fuel prices, while the pre-announced cuts will reduce households’ utility bills in April. These factors alone could reduce CPI inflation by 0.6ppts in April. The coronavirus crisis will also reduce core goods and services inflation, with the earliest effects likely to show up in the travel and tourism industries. Airfares rose by 5.3% m/m in February, but with demand having fallen off a cliff, big declines are in prospect in the months ahead. And we expect the increases in wage growth that we saw in 2019 to go into reverse, thereby weighing on core inflation, perhaps knocking off at least another 0.3ppts off inflation this year.
- One element which might potentially go in the opposite direction is food prices, which have probably held up well in response to the recent high demand especially for things like pasta, rice and tinned goods. And the near 10% drop in the sterling trade-weighted index over the past month could place some upward pressure on inflation. However, retailers may be forced to absorb some of the price rises. So the overall trend in inflation is still likely to be down and we think it will drop to below 1% in the middle of the year.
- We think that inflation will average just 1.2% in both 2020 and 2021 meaning that even by next year, there may be little pressure on the MPC to raise interest rates from the current all-time low of 0.10%.
Chart 1: CPI Inflation (ppts)
Sources: Refinitiv, Capital Economics
Table 1: Consumer Prices
Core % y/y
Fuel % y/y
Food % y/y
Ruth Gregory, Senior UK Economist, +44 7747 466 451, email@example.com