UK Inflation Report for April 2011

May 17 Inflation release by the Office of National Statistics (ONS), reported a larger than expected rise in annual inflation rate. The rate of inflation rose from 4.0% in March to 4.5% in April.  Chart.1 shows that annual inflation is not too far from the September 2008 peak of 5.2 %

 Chart.1 Inflation Historical Perspective

According to the ONS, the significant upward contributors to the annual rate of inflation were transport and household services. Transport costs were rose upward due to rising fuel and lubricant prices. Domestic heating costs and were the main categories that drove the cost of household services.

Chart.2 Inflation Rate Trending Upwards in the Past Year

Even shorter measures of inflation still show strong growth. Since bottoming in Q3 2010, both monthly and quarterly rates of inflation have accelerated.


Energy Prices continue to exert upward pressure on general prices in the UK economy. This inflation report may influence the Bank of England to act sooner. The latest Monetary Policy Committee minutes showed that 6 members voted against a rate hike, while 3 members voted in favour of hike. The doves were reluctant to raise interest rates due the fragility of the real economy, especially the household sector. The hawks feared that a sustained period of elevated inflation might result in medium term inflation expectations drifting upwards. This could result in demand for higher wages by employees.

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UK Inflation

“There is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012, boosted by the increase in VAT, higher energy and import prices, and some rebuilding of companies’ margins.”  The April 2011 Bank of England Inflation Report

In a prior blog I reviewed the main drivers behind the current run-up in the rate of inflation. The current rise in the rate of inflation has been attributed to the surge in commodity prices, energy prices and an increase in VAT. April 12 2011 CPI release reported an unexpected slow down in the growth of the annual rate inflation to 4.05% from 4.4%.

Chart.1 Inflation Growth Slows Chart.1 Inflation Growth Slows

 Inflation Growth Slows

In addition, the CPI constant taxes measure also lost momentum from an annual rate of 2.7% to 2.4%. According to ONS, the main drivers behind the pull back in inflation rate were food and non-alcoholic beverages, recreation and culture, and air transport.

Chart.3 Contribution to Monthly Change in CPI All Items Index

Inflation rose by 0.3% between February and March 2011, compared to 0.6% last year and 0.7% the prior month. Chart.2 highlights that the heaviest negative contribution to the monthly change in CPI was by food and non-alcoholic beverages. The ONS reports that:” the downward effects were widespread with the most significant coming from fruit, and bread and cereals. Fruit prices, overall, fell by 4.7 per cent, a record for a February to March period. Bread and cereal prices, overall, fell by 2.6 per cent, the largest ever monthly fall.”(ONS CPI report March 2011).

Significant upward contribution came from transport costs that rose by 1.2% in March. “The largest upward effects came from fuels and lubricants where pump prices rose by 2.7 per cent to reach record levels of £1.32 for petrol and £1.38 for diesel. There were also upward effects from air transport and the purchase of second-hand cars furniture, household equipment and maintenance: the largest upward effect came from furniture and furnishings where prices rose by 3.7 per cent”. (ONS CPI report March 2011).

Chart.4 Contribution to Annual Change in CPI All Items Index

Chart.3 depicts the percentage contribution of CPI constituent annual change in CPI. All CPI constituents contributed positively to the recent rise in annual inflation rate. The largest contributor to both monthly and annual inflation rates was transportation costs. The contribution from food & non-alcoholic beverages declined from 0.69 in Feb to 0.49 in March.


Oil and energy prices continue to exert heavy upward pressure on the rate of inflation as evidenced by contributions of transport costs, housing and household services. The recent slow down in the rate of inflation does provide a boost to the doves in the monetary policy committee of the Bank of England.

However according to the BOE:“there is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012, boosted by the increase in VAT, higher energy and import prices, and some rebuilding of companies’ margins.”  The April 2011 Bank of England Inflation Report

The May 17 report should shed some slight on the direction of trend in the rate of inflation.

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Australian Employment and House Prices

The recent Labour force release from the Australian Bureau Statistics reported that the unemployment rate decreased from 5.0% to 4.9%. What does this mean for house price inflation?

Chart.1 Unemployment in 2011

Chart.1 shows the recent employment rate at the beginning of the year to current. Most notable is the marked improvement in the unemployment rate in mineral rich West Australia and Victoria. Surprisingly, the unemployment rate in service dominated New South Wales rose by 0.5%.Unemployment for Australia as a whole was down 0.1%

Chart.2 Employment Growth and House Price

In the latest cycle, the momentum in house price growth has slowed. The slowdown in house price growth began prior to the slowdown in employment growth. This could be due to the interest rise resulting in a lack of affordability.

Chart.3 shows the employment levels (seasonally adj.) for the different states re-based to June 1991, the bottom of the last major recession.

Australian Employment Growth since June 1991

Queensland (up 78%) and West Australia (up 69%) employment growth has outpaced the rest of the nation since the bottom of the June 1991 recession. Tasmania (up 23%) and South Australia (up 27%) have been the laggards. Employment for the entire country rose by 39%. A prior blog post reviews the house price performance of eight main cities in Australia.

Despite low levels of unemployment, house price growth has begun to moderate due to affordability issues. It will be interesting to see if the next report, due on May 12, provides further evidence of a continued slow down on house price inflation. In the future I shall look at activity in the rental market.

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Inflation and Oil Price

Inflation was likely to pick up to between 4% and 5% in the near term, and to remain well above the 2% target throughout 2011, boosted by the increase in VAT, higher energy and import prices, and some rebuilding of companies’ margins. The projection for the first half of the forecast period was markedly higher than in November, due largely to the recent increases in the prices of commodities and other imported goods and services – according to the minutes from MPC meeting in Feb 9-10 2011

The statement from the MPC minutes and in the February Inflation Report provoked a review of the relationship between oil and general inflation. Previously, the relation between inflation and VAT was analysed. This post will examine the quote by from MPC minutes above.

Chart.1 Oil pushing up Consumer Price Index

Chart.1 shows the ebbs and flows between oil measured in sterling and the annual rate of inflation of UK consumer price index. It is evident the peaks and troughs in oils price precedes the peak and troughs of the inflation rate. The Middle East popular uprisings that began in December 2010resulted surge in oil price. Since December 17 2010, the beginning of Tunisian riots to March 14 2011, the price of oil has increased by 18%. During this period, mass demonstrations demanding devolution of power from politicians and royal families have occurred in Egypt, Bahrain, Morocco, and Libya. However, the Sterling Brent Oil Futures (as of March 14 2011), suggests that oil price may reach its apex; in May 2011. The BOE (MPC), in their deliberations over monetary policy will have to consider, whether oil price hikes are permanent or will prices will trend downward as calm returns to the region.

Furthermore, Chart.1 points out that the sharp run up in oil prices is not the sole driver behind the recent rise in the rate of inflation. The gap in growth of CPI all items and CPI excluding energy is marginal. This indicates other factors are causing inflation to rise.

Chart.2 UK Import Price and Oil Price

Chart.2 shows the relationship between the price of oil and UK import prices. Oil prices have led import prices since the oil price peak in mid-2008. Prior to this date, the relationship appears to be coincident.  The spread between growth in import prices all items and import price excluding energy was at widest at the turning points in oil price. This turning points being mid-2008 oil price peak and May 2009 trough in oil prices. Most recently, despite the surge in oil prices close to the mid 2008 peak the spread between imports price and import prices excluding has not widened significantly. Again this is due to other drivers of import prices, that are not energy related

Table.1 Correlations of Oil, Import Price and Inflation






Table.1 highlights the correlation coefficients between oil and the three measures of inflation. As anticipated, oil has as a stronger contemporaneous relationship with all the price measures.The intensity of correlation is strongest with CPI all items and correlation intensity is strongest when the price of oil is led by three months.

Chart.3 Inflation Energy and Commodities

*Oil and Commodity prices in converted to Sterling

Chart.3 depicts energy, commodities and inflation measures re-based to September 2009 trough in the annual rate of inflation. Chart.3 highlights strong run ups in energy and commodity prices due to the recovery in global economic activity.  In the early parts of 2009 oil and metal price growth led agricultural products. However, from mid 2010 the price of foodstuffs has risen at a faster pace. However, the rate of growth in agricultural commodity prices has slowed.  The strong surge in agricultural and industrial metal prices as measured by S&P Goldman Sacs Commodity Index (S&P GSCI) has meant the spread in the annual change in overall CPI and CPI excluding energy has been smaller.


Energy and commodity prices spikes have resulted in higher levels of overall inflation. Will the BOE respond by tightening monetary policy? The response of the BOE will depend on whether this impact is transitory or permanent. Have consumers’ and businesses’ medium term inflation expectations risen? Will raising interest rates derail the fragile economic recovery, especially given the coalition government’s tight fiscal policy? Energy and commodity prices are determined by the global markets. Are higher domestic interest rates able to counter balance rising global demand from emerging markets? Economists that are in favour of tighter monetary policy argue that an increase in sterling can cushion rising commodity prices. India and China, the primary drivers of global demand for commodities have adopted less accommodative monetary polices. This could result in slower growth and a weakening in demand for commodities.  In short, there is much uncertainty about the current economic backdrop for UK. We are still to see and feel the full impact of the government’s fiscal retrenchment. The latest UK GDP figures for Q4 2010 reported a weather induced 0.6% decline in output. There is still significant capacity in the UK economy with unemployment at a 17 year high of 8%. Additionally, wage growth has remained subdued, indicating that workers are not demanding increased compensation for loss of purchasing power.  The Phillips curve lives: growth or inflation. With elevated unemployment levels, it is difficult to justify higher rates.

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Australian House Prices Returning to Trend in 2011?

The most recent (released Feb 1 2011) house price data positive trend for the eight capital cities.

The Australian Bureau Statistics using a clustering approach. The property clustered based on specific attributes. The weights are at the cluster level, according to the importance of the cluster at the city level (ABS).

Chart.1 depicts the house price index of the weighted average of eight capital cities of Australia.

Chart.1 House Prices Returning to Trend?

House price seem to be peaking, after showing a strong recovery after the credit crunch. More recently, the deviation from trend appears to be short-lived

Chart.2 Is House Price Growth Losing Steam?

Chart.2 shows both the annual and quarter on quarter on growth in house prices.  The pace of house price growth has decelerated. The slow down in the rate of growth in house prices has be attributed to RBA raising the cash rate 4 times since December 2009 (3.75%) until November 2010 (4.75%). ; the end of first home owner boost; tighter foreign investment rules and a strong Aussie dollar.

Chart.3 depicts the price performance of house price in different states (re-based to Q1 2002). Surprisingly, the chart show Sydney is lags the other capital cities throughout the time shown on chart. While, Perth, which outperformed other cities from June 2006 until December 2007, is showing signs that house prices have rolled over. Hobart has been the leading performer since mid 2008. Most evident is that the pace of the house price growth has slowed.

Chart.3 8 Capital Cities for Price Performance

In the short-medium term, we can expect house price growth to moderate. The main drivers influencing the medium term outlook will be:

  • RBA Monetary policy: specifically the direction of the policy rate
  • Economic : especially the terms of trade and economic growth in Asia
  • Supply side issues: persistence of sluggish building levels

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UK Inflation Rises: Blame it on VAT

The recent CPI releases reported a rise in consumer price index of 0.1% (for the month) and 4.0% annually. Chart.1 shows the ebbs and flow different measures of inflation: CPI all items, CPI excluding indirect taxes and CPI at constant taxes. The annual measures of the rate of inflation moved in unison and at similar levels up to the September 2008 inflation peak. The peak inflation coincides with announcement of VAT concession. In December 2008, the standard VAT rate was lowered to 15% from 17.5%. During the VAT concession period CPI all items that includes indirect taxes similar to VAT declined at faster rate relative to inflation measures that exclude taxes or hold taxes constant.

Chart.1 CPI and VAT

However, the pace of the CPI all items accelerated from September 2009, as the VAT concession was set to expire in December 2009. This resulted in a widening between inflation measures. As part of the deficit repair, the ConLib government raised the standard VAT rate from 17.5% to 20%. Chart.2 highlights the effect of the VAT rise on the inflation rate of goods and services. The largest impact is on energy related products, while food was the least impacted.

Chart.2 Effect of VAT


According to Mervin King in his letter  to the Chancellor “….three factors can account for the current high level of inflation: the rise in VAT relative to a year ago, the continuing consequences of the fall in sterling in late 2007 and 2008, and recent increases in commodity prices, particularly energy prices. Although one cannot be sure, prices excluding the effects of these factors would probably have increased at a rate well below the 2% inflation target.” How long inflation remains at above the target rate depends on the inflation expectations of households and companies. Persistent levels of high inflation expectations may result in companies rising prices and households demanding higher wages. My tentative analysis on expectations (will be published soon) shows that household near term inflation expectations have risen.  Anecdotal evidence suggests that the market expectations on the timing of the BOE rate hike have shifted. Expectations of a rate hike are sooner rather than later. This may result in a rise in mortgage rates and potentially more repossessions.

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The recent release of the Halifax house price index surprisingly reported a 0.8% month on month rise in Jan 2011. Chart.1 below shows that monthly change has become less predictable. My view is that the low transaction volumes have lead to increased uncertainty in short-term measures of house price momentum. The standard deviation of monthly change in house prices has risen two-fold since mid 2006.

Chart.1 House Price Monthly Change – Unpredictable

However, the medium term measure indicates a downward trend in house price. Chart.2 shows the popular and less volatile indicator of house price trend, 3 month on previous 3 month.  This indicator peaked in Nov 2009, and recently the rate of decline in house prices as decelerated. In Jan 2011 3 month on previous 3 month declined 0.7 %,( Dec 2010 0.8%), for the eighth consecutive month.

Chart.2 3 month 3 month Change- Downward Trend decelerated


Consequently, the annual change in house prices continues to decline, erasing the gains made in the early part of 2010. In terms of prospects for 2011, Halifax states: “We expect limited movement in house prices overall this year. There are, however, likely to be some monthly fluctuations with the risks on the downside.”


In previous blog it was highlighted that the balance of demand and supply will dictate the pace house price growth. Halifax takes a similar view:”On a positive note, there have been further signs that the recent downward trend in prices is causing homeowners to be more reluctant to put their properties on the market.” The actions of sellers and buyers will determine the direction and pace of house prices. My 2011 view is that prices will follow downward trend, at moderate pace. The moderate  pace is due in part to low interests  rates and positive rental trend. This results in lower levels of new instructions (inflow of existing stock). A headwind for the house prices is the tight mortgage market characterized high loan to value levels. This restrains new buyer enquires. Thus, the balance of between the indicators will determine prices.

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