Brexit vote-fuelled inflation is washing out of the system but interest rates may still rise as soon as May

Inflation is coming down more quickly than the Bank of England expected as the impact of the post-EU referendum fall in the value of sterling washes out of the system.

That was the good news from official data showing that the government’s preferred measure of the annual increase in the cost of living dropped from 3% in January to 2.7% in February.

The bad news for homeowners worried about having to pay more to service their mortgages is that the easing of inflationary pressure may not influence the Bank’s monetary policy committee’s decision all that much. The Bank still wants to raise rates and could do so as soon as May.

Threadneedle Street always thought the Brexit-influenced spike in inflation was likely to prove temporary. Sterling fell on the foreign exchanges after the Brexit vote in June 2016 and over the next year dearer imports led to the CPI measure of inflation rising from 0.5% to 2.6%. In the second half of 2017, inflation briefly topped 3%.

But the annual inflation rate assesses what has been happening to prices over the latest 12-month period and as a new month comes in an old month drops out. The months that are now dropping out – in early 2017 – were when the effects of a weaker pound were most marked.

Of more concern to the Bank is the state of the labour market. It believes an unemployment rate of 4.4% – only marginally above its lowest since the mid-1970s – is starting to put upward pressure on wages.

Earnings growth has been creeping up and before too long earnings will be increasing more quickly than prices. The sharper than expected fall in inflation means the return to rising real incomes will occur sooner and that will mean stronger growth and – from the MPC’s perspective – the threat of higher wage inflation.

While there has been little in recent economic data to justify a May increase in rates, earnings data will be crucial. If the annual increase edges closer to 3%, a spring rise will be a real possibility.

LEAVE A REPLY