Inflation has begun a rapid descent back to target - ITEM Club

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  • The first step in what is likely to be a rapid descent back to target
  • Weaker external outlook increases the probability that inflation will undershoot in 2 years’ time
  • Tomorrow’s inflation report likely to prepare the ground for further loosening of policy
“This should mark the beginning of a relatively rapid descent back to the 2% target. Global commodity prices have fallen sharply in recent months and there is already evidence that this is being reflected in weaker inflationary pressures at the factory gate; we would expect this to pass further along the supply chain in the near future.  When you also consider the fact that the VAT rise and sharp increases in petrol prices will drop out of the year-on-year calculation early 2012, we think it likely that inflation will be back below 2% by this time next year. There is certainly some light appearing at the end of the tunnel for the hard-pressed consumer.
“Indeed, the weaker external outlook has increased the likelihood that inflation will undershoot the target at the two-year horizon. Already in this release there is evidence that food retailers are reacting to intense competitive pressures by discounting and we would expect to see this broaden out to other sectors, particularly if the recent slowdown in demand intensifies. Furthermore, if global growth continues to disappoint there is likely to be further downward pressure on commodity prices.
“Against this backdrop it isn’t hard to see why the MPC has felt the need to loosen monetary policy, even if we are not entirely in agreement with the method they have adopted. There is a strong probability that tomorrow’s Inflation Report will carry a central forecast where inflation is below 2% at the two-year horizon, as well as a much weaker GDP profile, preparing the ground for further policy loosening in the near future. All indications from the MPC to date suggest that this would take the form of further gilt purchases early in the new year, though we are sceptical as to whether this would have as big an impact as the first round of QE did back in 2009.”