The June 17 Inflation release by the Office of National Statistics (ONS), reported a larger than anticipated annual inflation rate of 4.5% unchanged from April. Annual inflation as measured by CPI has remained above the inflation target of 2% for the 17 consecutive months
Chart.1 Contribution to Annual Inflation Rate
Transport remained the largest contributor with a 1.3% point increase, however this was less than the sector’s 1.53 percentage point contribution in April. The largest effects came from fuels and lubricants where prices rose by 13.7 per cent over the 12 months to May and air transport where fares rose by 13.8 per cent over the same period. Food and non-alcoholic beverages contributed 0.64% percentage points with prices up from 0.47% in April. All categories within the division contributed positively to the upward pressure to the 12-month rate.
Chart.2 Inflation fuelled by Food and Energy
Chart.1 above shows UK CPI index all items (NSA) and all items excluding various components, rebased to Jan. 1996. The CPI all items index rose at a faster rate of 37.6% since 1996when compared to a 28% rise in the CPI excluding food energy. Interestingly, until late 2004 CPI excluding food and energy was at the same level as the overall CPI index. The difference between the two inflation measures highlights the upward contribution that food and energy components have made on general prices in the economy.
Chart.3 Volatile CPI Components
Chart.3 shows that the utility bills annual rate of inflation has lagged the other components. Annual growth in the series began to accelerate after Q1 2010. Evident from Chart3 is the high levels of volatility exhibited by the CPI sub-components, especially the energy related components.
Chart.4 Household Inflation Expectation above Inflation Target
Chart.4 reports the household inflation expectations, over 12, 24 and 60 months as surveyed by Gfk NOP on behalf of the Bank of England (BOE). Both long term and near term measures of household inflation expectations are above the BOE’s 2% target (yellow line in chart.4). Inflation expectations bottomed in late 2009. Since 2010’snear term measure of inflation, expectations have increased at faster rate than the medium to long term measures. Long-term measures of household inflation expectations are less elevated (or are at levels closer to the inflation target) than the near term measures. This could imply that household inflation expectations are anchored to the inflation target.”What is of interest for monetary policymakers such as us in the MPC are signs that expectations have become de-anchored, which we can interpret as being the case if the public reacts to a short period of higher than expected inflation by increasing their long run expectations.”(David Blanchflower, 2008). Alternatively, if inflation is less anchored, public view the deviation of the current rate of inflation from the inflation target as being permanent. That might make inflation itself more stubborn, via changes in price and wage-setting behaviour. Chart4 shows that after creeping upwards, inflation expectations have declined in Q2 2011. This may provide some vindication for the dovish members of the BOE.
The latest Bank of England Gfk NOP inflation expectation survey (see BOE Quarterly bulletin especially pages 100-110) reasserts the BOE’s belief that long-term expectations remain anchored to the bank’s monetary policy framework. In my view, the central bank’s current monetary policy stance is driven by the tepid economic recovery, as opposed to the extent to which long-term inflation expectations are anchored. It is unlikely that BOE will raise interest rates in the current economic climate, despite above target inflation.