News & analysis

Headline UK inflation dropped marginally more than expected in February, with prices rising by 3.4% on a YoY basis.

Whilst this was a decline from 4.0% YoY rise recorded in January, and a 0.1pp undershoot of consensus expectations, today’s figures offer no reason for a change in thinking at the Bank of England, where a rate decision is due be delivered tomorrow and a continued hold in rates is widely expected. Importantly, inflation outturns continue to track broadly in line with Bank staff forecasts, and April’s rise in the National Living wage remains the key risk for policymakers.

All told, this should give the MPC confidence to run back February’s messaging tomorrow with a largely unchanged rate statement, which in the context of further disinflation progress, should on balance be seen as marginally hawkish by markets.

Looking purely at the main inflation readings, the disinflation progress seen in February’s figures would at first glance appear to be pretty welcome news for policymakers. Both headline and core inflation fell 0.1pp more than expected, with the latter easing from 5.1% to 4.5% last month. Bank staff forecasts had predicted CPI growth to fall to 3.5% YoY in February, followed by a further decline to 3.1% in March. As such, the latest set of data which show inflation falling to 3.4% in February means headline CPI is only marginally tracking below those projections, representing good progress, whilst not suggesting that the Bank’s inflation forecasts are wildly inaccurate, something that has been an issue over recent years.

That said, we still suspect the MPC will strike a note of caution tomorrow as a result of services inflation, with the measure closely watched by policymakers as an indicator for sticky inflation pressures.

This overshot market expectations by 0.1pp, falling from 6.5% to 6.1% YoY, though admittedly this leaves the measure exactly in line with the 6.1% forecast by Bank staff in the February MPR. But with services inflation set to cool much more slowly than headline readings over the coming months, only falling to 4.9% in May according to Bank forecasts, this suggests to us that it remains a little too early for the MPC to put the champagne on ice.

This is doubly true when considering the major upside risk still facing the BoE in coming months, namely, what impact does the April 1st rise in the National Living Wage have on price pressures. The details of today’s release are hardly likely to dispel these worries either.

Significantly, the two largest components of headline CPI are now the restaurants and hotels (+0.83%) and recreation and culture (+0.74%), with both sectors highly wage sensitive and likely to be disproportionately affected by the NLW rise. Granted, the first of these was also amongst the biggest contributors to the fall in YoY price growth between January and February alongside food and non-alcoholic beverages, collectively subtracting -0.36pp from headline price growth. But given that last year’s February price collection coincided with Valentine’s Day, which was not the case this year, it suggests that the fall in these aggregates is somewhat less impressive than it first appears.

Similarly, even as disinflation progress continues, forward looking indicators have also sounded a note of caution in recent months. Most recently, this was seen in the February services PMI which pointed to the second-fastest rate of increases for prices charged since July 2023, exceeded only by the December reading.

With anecdotal evidence also suggesting that resilient customer demand is allowing firms to pass on higher costs too, particularly from rising wages, this should see the BoE remaining cautious in the coming months. As such, we expect little change in tone from the BoE tomorrow, and no change in Bank Rate until August, the earliest meeting by our estimation that the MPC will feel comfortable that rising wages have not sparked another round of upside inflation pressures. With markets currently pricing the odds of a June rate cut at 60%, this would be a more hawkish outcome than currently priced.

Given this, we expect further alignment with our view over coming months should see markets pushing the pound modestly higher. For now though, today’s broadly on expectations prints have been taken in stride by FX markets, an outcome that leaves the pound trading fractionally below pre-release levels.




Nick Rees, FX Market Analyst



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