In line with consensus, the UK inflation rate declined back to 0.0% in June, down from 0.1% in May. Core inflation declined to 0.8% in June down from 0.9% in May.
The largest downward contribution came from clothing and footwear, which pulled the inflation rate down 0.07pp. The reason is the timing of summer sales. Usually prices fall between May and June but prices rose unexpectedly from May to June 2014. This year prices declined 0.4% m/m implying a large downward contribution when looking at the annual change in the consumer price index.
Food prices declined 0.2% m/m in June compared to a small rise of 0.1% m/m last year, implying that food prices also pulled the inflation rate down by 0.04pp.
Fuel prices increased further in June and the negative effect from the lower oil prices on inflation has begun to decline. However this was more than offset by air fares.
The strong sterling continued to pressure non-energy industrial goods prices. The annual rate of change declined to -1.5% in June from -1.1% in May, implying a negative contribution of 0.1pp to the overall change in inflation in June.
The main reason why inflation has been at a record low this year is the falls in energy and food prices. That said, non-energy industrial goods prices are also lower than a year ago due to strong sterling lowering import prices. The annual rate of change in services prices, which to a large extent is generated domestically, remained above the Bank of England's 2% target, this was still low in a historical context.
We still expect CPI to pick up sharply at the end of this year when the base effects of the declines in energy and food prices begin to drop out. In other words, the very low inflation is likely to be only temporary. This should have the advantage of boosting consumption, and hence the UK's recovery, as UK citizens experience positive real wage growth for the first time since 2009.
We still expect the MPC to hike rates in November this year as the medium-term inflation outlook still calls for tighter monetary policy, in our view. The low core inflation, strong sterling and the timing of the first Fed hike present downside risks to our call, as they imply that the MPC may be more patient with the bank's first rate hike. However, the 'conditional deal' between Greece and its creditors implies less uncertainty with respect to the economic recovery in Europe going forward and thus is supportive for our November call.
The unemployment rate and average weekly earnings figures are released tomorrow and will likely attract more attention. Wage growth has been increasing since summer last year and was at its highest level since the financial crisis in April. It seems that the tightening in the labour market over the last couple of years has finally caused wages to increase. Higher wage growth is important for inflation to increase back towards the 2% target and thus is a key determinant for the timing of the first BoE hike.
See the following page for illustrative charts.
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