- Consumer price inflation unexpectedly dipped to a three-month low of 0.4% in February from 0.7% in January. The consensus had been for a small rise to 0.8%.
- Inflation of 0.4% is supportive to consumers’ purchasing power and is more than one percentage point below the Bank of England’s 2% target.
- Inflation was primarily brought down in February by prices for clothing, second-hand cars and games, toys and hobbies. Inflation also continues to be limited by the temporary VAT cut for the hospitality and leisure sectors.
- Upward pressure on inflation in February came from transport prices (primarily motor fuels) and prices for housing and household services.
- Core inflation fell back to a six-month low of 0.9% in February from 1.4% in January and December.
- There was evidence of a pick-up in price pressures further down the supply chain in February. Producer input prices rose 0.6% month-on-month (m/m) and 2.6% year-on-year (y/y) after y/y increases of 1.6% in January and 0.6% in December. Meanwhile, producer output prices rose 0.6% m/m and 0.9% y/y after an increase of 0.1% y/y in January and fall of 0.5% y/y in December.
- The EY ITEM Club expects consumer price inflation to move significantly higher over the coming months and considers February’s level to mark its low point. Unfavourable base effects resulting from the fall in oil prices in early 2020 will have an upward impact, magnified by the recent rise in oil prices to one-year highs. Energy prices for millions of consumers will rise in April after the price cap was raised. After a challenging Q1, an expected progressive firming of the economic recovery from early-2021 will also have some upward impact on inflation.
- There will also be some upward impact on inflation in October after the temporary VAT level for the hospitality and tourism sectors is raised to 12.5% at the end of September.
- Consequently, the EY ITEM Club sees consumer price inflation approaching 2% during Q2 and then rising just above 2% during the second half of the year. However, inflation is not expected to rise much above 2% due to spare capacity in the economy and labour markets.
- The EY ITEM Club suspects that the Bank of England’s ultimate next move will be to tighten policy, initially through edging interest rates up from the current level of 0.10%. The EY ITEM Club believes the Bank of England is most likely to hold off from acting throughout 2021 but there is clearly a growing possibility that the Bank could tighten monetary policy in 2022 – although at the moment, early-2023 seems more likely.
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“Consumer price inflation unexpectedly fell back to a three-month low of 0.4% in February after rising to 0.7% in January. This was up from 0.6% in December and a then-three-month low of 0.3% in November. The consensus expectation had been for inflation to edge up to 0.8% in February.
“Inflation was primarily brought down in February by prices for clothing, second-hand cars and games, toys and hobbies. Clothing prices have not followed normal seasonal patterns since early-2020 due to the impact of COVID-19.
“Additionally, inflation continued to be held down in February by the temporary VAT cut introduced last July for the hospitality sector, hotel and holiday accommodation and admission to certain attractions.
“Core inflation fell back significantly to a six-month low of 0.9% in February after rising to 1.4% in January and December from 1.1% in November and 0.9% in August.
“Upward pressure on inflation in February primarily came from higher transport prices, largely due to increased fuel prices. There was also some upward pressure from prices of housing and household services.
“At 0.4% in February, consumer price inflation was more than one percentage point below the Bank of England’s 2.0% target rate.”
Measuring of inflation in February affected by restrictions
Howard Archer continues: “The Office for National Statistics (ONS) noted that, ‘As a result of the ongoing restrictions caused by the COVID-19 pandemic in February 2021, the number of CPIH items identified as unavailable was 69, accounting for 8.3% of the basket by weight; this is unchanged from January 2021 but lower than the 72 items that were unavailable during the lockdown in November 2020; for the February 2021 price collection, we collected a weighted total of 81.1% of comparable coverage collected before the first lockdown (excluding unavailable items).’”
Outlook for inflation
Howard Archer adds: “February’s is highly likely to mark inflation’s low point. The EY ITEM Club expects inflation to move markedly higher over the coming months.
“Unfavourable base effects resulting from the fall in oil prices in the early months of 2020 will have a significant near-term upward effect on inflation. This will be magnified by oil prices recently trading at their highest level for 13 months. Additionally, energy prices will rise for many consumers from April following the recent decision to raise the cap on the most widely used tariffs by 9.2%.
“An expected progressive firming of the recovery from the second quarter of 2020 will also likely have some upward impact on inflation.
“Additionally, there will be some upward impact on inflation in October after the temporary VAT cut for the hospitality and leisure sectors is diluted to 12.5% – from 5% – at the end of September. There will be a further upward impact on inflation in April 2022 when the VAT rate rises back up to the full rate of 20% at the end of next March.
“There was evidence of a pick-up in price pressures further down the supply chain in February: producer input prices increased 0.6% month-on-month and 2.6% year-on-year after year-on-year increases of 1.6% in January and 0.6% in December. Meanwhile, producer output prices rose 0.6% month-on-month and 0.9% year-on-year in February after a rise of 0.1% year-on-year in January and fall of 0.5% year-on-year in December.
“Consequently, the EY ITEM Club expects consumer price inflation to approach 2% during the second quarter and to rise just above 2% during the second half of the year. However, the EY ITEM Club does not expect inflation to rise much above 2% as there will still be excess capacity in the economy and in labour markets.”