UK CPI inflation declined to 0.0% y/y in August, from 0.1% y/y in July (Danske Bank 0.0% y/y, consensus 0.0%). Core inflation dropped to 1.0% y/y in August from 1.2% y/y in July, in line with expectations.
Looking at the details, the drop in headline inflation was mainly due to 'clothing and footwear' which pushed the inflation rate down by 0.1pp. It is still the timing of the summer sales last year which affects CPI headline. Another major contributor to the decline in headline inflation was 'fuels and lubricants' which pushed inflation down (-0.05pp). While deflation in gasoline prices increased only slightly in August, deflation in diesel prices rose sharply. The current oil price level suggests that fuel prices - especially gasoline prices - could drop further going forward.
'Non-alcoholic beverages' and 'furniture and furnishings' both pushed headline inflation up by 0.04pp.
'Clothing and footwear' was also the main contributor to the decline in the core inflation. Lower sea transport fares (which are quite volatile) pulled down services inflation and thus core inflation. Services inflation declined to 2.3% y/y in August, from 2.4% in July. Services inflation is low from an historical perspective but still above the BoE's 2.0% target. It is important to remember that services prices are more domestically generated than other components.
The Bank of England's (BoE) focus has shifted back to inflation in the wake of lower oil prices and stronger sterling. We think the BoE wants to see CPI inflation stabilise/move higher before hiking and hence most MPC members are unlikely to feel comfortable with the near-term inflation outlook. Both we and the BoE anticipate that CPI inflation will stay around 0% for the rest of the year but one cannot rule out that inflation could turn negative again. We expect CPI inflation to pick up close to 1% in January 2016, which should reduce concerns among MPC members, and thus we expect the BoE to deliver the first hike in Q1 16, probably in February.
EUR/GBP and GBP/USD are likely to remain volatile ahead of the FOMC meeting Thursday.
The UK labour market report due tomorrow (Wednesday) and retail sales due on Thursday will probably attract attention. This is especially true for the average weekly earnings excluding bonus which we expect increased to 2.9% y/y in July from 2.8% y/y in June.
To Read the Entire Report Please Click on the pdf File Below.