UK CPI inflation in December 2014 came out lower than expected at 0.0% m/m and 0.5 % y/y. Inflation is now at the lowest rate since May 2000.
The lower inflation is caused by lower oil prices and the supermarket price war. Prices of motor fuels fell 10.5% y/y while food prices fell 1.9% y/y. In total, they reduced CPI inflation by approximately 0.6 percentage points. Both are expected to keep CPI inflation low during 2015.
Core inflation increased from 1.2 % y/y in November 14 to 1.3 % y/y in December 14. Still, the low core inflation reflects that the underlying inflation pressure is still subdued.
Given that the CPI inflation is now more than 1 percentage point below the Bank of England's 2% target means that the Bank of England's Governor Carney is now required to write a letter to the Chancellor of the Exchequer George Osborne explaining why. The last time was back in February 2012, when the former Bank of England Governor Mervyn King had to explain why inflation was above 3%. This letter will be published on 18 February at the same time as the publication of the minutes of the next MPC meeting. However, this will be a non-event, in our view, as Carney will argue that the low inflation is caused by the lower oil prices. Also, Carney has previously stated that 'the recent sharp fall in the oil price should support global and UK growth'.
The Bank of England can be patient, increasing the bank rate due to low inflation. We still expect the first hike in Q3 15.
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