Surprise jump in inflation – Market reaction

Year-on-year CPI inflation rose to 1.6 per cent in December, 0.2 per cent higher than market expectations, with the impact of the weak pound on the cost of imports largely responsible for the increase.

inflation word on a newspaper

Experts are predicting more increases through 2017 as the impact of the devaluation of sterling feeds into higher prices. But stock and currency markets were largely unaffected by the figures. Economists predict that once the one-off inflation hike caused by sterling’s devaluation has worked its way through the system, the economy will see low inflation again, with interest rates expected to remain low over the long term.

RPI inflation rose to 2.5 per cent in December, up from 2.2 per cent the previous month.

ONS head of inflation Mike Prestwood said: “This is the highest CPI has been for over two years, though the annual rate remains below the Bank of England’s target and low by historical standards.

“Rising air fares and food prices, along with petrol prices falling less than last December, all helped to push up the rate of inflation.

“Rising raw material costs also continued to push up the prices of goods leaving factories.”

Aegon head of pensions Kate Smith says: “Today’s increase in price inflation is a sharp reminder that people’s buying power can change over a relatively short period of time and this can be particularly hard for those on fixed incomes, which includes many pensioners. Increasingly people are living 20 or more years in retirement and even low-level inflation can erode the value of retirement income over time. In under 20 years the value of £100 has more than halved, which could severely restrict pensioners’ spending power and quality of life.

Investec Wealth & Investment bond strategist Shilen Shah says: “The year on year CPI print for December came in 0.2 per cent higher than the consensus figure of 1.4 per cent as the sharp fall in sterling’s value pushed up import prices. Import prices themselves jumped by 16.9 per cent year on year and this is a sharp indicator that consumers are likely to be faced with further price pressures in 2017.

“As indicated by Governor Carney, the BoE’s patience in relation to inflation overshooting its target is limited, with the core CPI figure coming in at 1.6 per cent, indicating that price pressures are likely to accelerate over the course of 2017.”

Royal London Asset Management economist Ian Kernohan says: “From a very low starting point, UK Inflation is now picking up quite sharply.  Rising food and fuel inflation were the key features of this month’s data, and these are non-discretionary elements of household budgets.  The full impact of sterling’s depreciation has yet to be seen, and with nominal wage growth still quite muted, we expect consumer spending to weaken this year, in the face of a squeeze on real household incomes.”

Hargreaves Lansdown senior economist Ben Brettell says: “Consensus forecasts had pointed to a smaller increase to 1.4 per cent. This is the highest rate since July 2014. The market reaction to the figures was muted, with both the FTSE and the pound largely unaffected.

“The main contributors to the acceleration in inflation were motor fuels, air fares, food and clothing – all of which have been affected by the weak pound. Food producers have faced sharply rising input costs, while oil is of course priced in dollars.

“December’s producer price data contains a strong indicator that higher inflation is coming. Input costs rose 15.8 per cent year-on-year – the highest figure recorded for more than five years. It’s unlikely cost increases of this magnitude can be fully absorbed by firms, leaving them with little choice but to pass some on to consumers in the coming months.

“The Bank of England says CPI inflation will exceed the 2 per cent target by the middle of the year, though I wouldn’t be surprised if it happens sooner than that. Mark Carney also says the resulting squeeze on household budgets will cause the economy to slow as we move through 2017.

“However, the effect of the weak pound, assuming it doesn’t fall much further, is a one-off factor which will fall out of the figures eventually. The longer-term picture is one of structurally low inflation – due in part to demographic reasons. The baby boomers are starting to retire and have already gone thorough their consumption phase – they have bought their houses, cars and consumer goods. The younger generation is saddled with debt and struggling to get on the housing ladder. Workers don’t have the bargaining power over pay they once did, and wage growth looks set to be anaemic at best.

“All this should mean less inflationary pressure and relatively lacklustre economic growth. Assuming the Bank of England is prepared to ‘look through’ what looks like a temporary spike in inflation, this should mean interest rates remain at rock bottom for the foreseeable future.”

Prudential retirement expert Vince Smith-Hughes says: “Rising inflation will squeeze the living standards of retired people living on a fixed income, particularly as they often spend a disproportionate amount of their income of fuel, food and heating.  Pensioners drawing down an income for their pension funds will have to think again about how much they draw from their funds. Increasing the amount they take increases the risk of prematurely exhausting their pension leaving them with only the State Pension to live on.”