The sharp fall in inflation from 0.7% in October to 0.3% in November (consensus 0.6%) and in the core rate from 1.5% to 1.1% came as a bit of a surprise. However, some of these moves were driven by one-off factors, so we still expect inflation to rise temporarily back towards the 2% target next year. Beyond that, we expect inflation to settle at 1.5%. That is unless a no deal Brexit pushes it up to a peak of 3-4%.
Low inflation won’t prompt the MPC to act
- The sharp fall in inflation from 0.7% in October to 0.3% in November (consensus 0.6%) and in the core rate from 1.5% to 1.1% came as a bit of a surprise. However, some of these moves were driven by one-off factors, so we still expect inflation to rise temporarily back towards the 2% target next year. Beyond that, we expect inflation to settle at 1.5%. That is unless a no deal Brexit pushes it up to a peak of 3-4%.
- By far the biggest factor behind the drop in CPI inflation was the fall in clothing inflation (0.0% to -3.6%). And as we had expected, some pandemic-induced bursts of inflation continued to ease. IT equipment dropped further from 6.4% in October to 4.1% in November. Hairdressing inflation fell from 6.1% to 5.8%. Second-hand car price inflation also dropped from its 10-year high of 10.7% in October to 8.5%. What we hadn’t anticipated was the slump in food inflation from +0.6 to -0.6%, which came despite the boost to demand for food in the supermarkets during the second COVID-19 lockdown. Meanwhile, the accommodation and hotels and communication sectors were the only major sectors to register an increase in inflation, from -6.5% to +1.1% and 3.3% to 3.5% respectively.
- But some of these moves should be reversed in the coming months. The dip in clothing inflation was partly driven by Black Friday discounts starting earlier than usual. And many accommodation prices were unavailable during the second lockdown and so were based on assumptions.
- And this does not change the big picture that inflation will start to rise more sharply from April when the temporary VAT cut for the hospitality sector is reversed and the downward drag from the previous plunge in fuel prices drops out of the annual comparison. Together these forces could lift inflation to 2% in late 2021, although we suspect that a lot of economic slack will prevent it spending much time above target.
- Overall, we do not think that November’s drop in inflation will prompt the MPC to announce any further policy stimulus at its meeting tomorrow. In fact, we are not expecting any action tomorrow and potentially not for some time to come, unless there is a no deal Brexit. In that case, we think the MPC would look through the temporary rise in inflation (see Chart 1) and instead focus on quashing any financial market dislocation and supporting demand. (See here.)
Chart 1: CPI Inflation (%)
Sources: Refinitiv, Capital Economics
Table 1: Consumer Prices
Core % y/y
Fuel % y/y
Food % y/y
Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, email@example.com