News & analysis

January’s inflation numbers notably undershot expectations in this morning’s release, offering a counterpoint to yesterday’s hotter than anticipated labour market figures. Headline inflation stabilised at 4.0% YoY, despite expectations for an uptick to 4.1%.

More importantly for the Bank of England, services inflation only marginally increased, rising by 0.1pp to 6.5%. This leaves services inflation now tracking below BoE projections, despite widespread consensus that looked for an upside beat as a sharp drop in prices from twelve months ago fell out of annual calculations. Taken in the context of yesterday’s hot wage prints, this could on its face pose something of a head scratcher for the BoE. Strong wage growth should, at least in theory, be propping up services inflation, a point notably made by policymakers over the past year. Yet that does not seem to be the case based on today’s figures. Instead, it appears that this relationship is beginning to weaken, at least for now, a point we think was hinted at in recent PMI releases. Even so, today’s figures should do little to change the calculus on Threadneedle Street. While policymakers would likely welcome reduced passthrough from wages to inflation, strong pay growth still poses upside risk, especially with April’s National Living Wage rise looming.

We continue to expect a first rate cut in August, the earliest date we think policymakers can be comfortable that wage pass through has continued to remain weak, and that the NLW rise has not sparked a reacceleration in pay growth.

Looking through today’s figures in detail, it is not headline CPI that grabs the attention this time around. Admittedly, on a monthly basis, headline prices fell outright by -0.6%, far greater than the -0.3% drop-off expected by markets. But after spending much of the past few years as notable contributors to headline CPI, both food and energy costs are no longer the key drivers for annual price growth. Indeed, food and non-alcoholic beverages only contributed 0.8pp of the headline wage growth in January, having now been overtaken or matched as upwards contributors to headline price growth by restaurants and hotels (1.0pp), other goods and services (0.9pp) and recreations and culture (0.8pp). Given this, adjusting for the impact of volatile food and energy components does little to change the picture. Core inflation also stabilised in January on an annual basis, printing at 5.1%, in line with December’s reading.

Of course, the focus for policymakers remains underlying inflation pressures rather than headline readings,  understandably so given that annual inflation is now being propped up by a handful of wage sensitive sub-indices related to services activity.

This point was emphasised by the BoE at the February rate decision, where new inflation forecasts showed YoY CPI temporarily returning to target in the middle of 2024. For the MPC to be sure inflation will get back to 2% and stay there, policymakers need to see further softening in underlying inflation pressures, and in particular, the passthrough of wages to inflation. On this score, we think they will be able to draw some welcome conclusions from today’s release. Despite the notable impact of restaurants and hotels and recreations and culture on annual figures, they offered only a marginal impact on a monthly basis. This suggests that inflation momentum, even in wage sensitive components, is now slowing. Significantly, this dynamic was highlighted by January’s PMI report, suggesting that while strong wage pressures continued to push up operating expenses, these were offset by easing fuel and raw material costs, and that combined with competitive pressures, this led to the lowest rise in prices charged since last September.

Looking ahead, inflation is now on track to fall to around 2% in April, in line with BoE forecasts, as energy base effects see price growth temporarily return back to target.

If the slowing momentum in services inflation can be sustained too, we think this should see the MPC easing rates in the middle of this year. That said, there are several key risk events that muddy the waters on the outlook for services CPI, most notably a budget in March followed by April’s rise in the National Living Wage. The former of these is likely to have only a marginal impact for the BoE in our view, especially given what we think is limited room for fiscal manoeuvring by the Chancellor. The latter, however, could see wage growth reaccelerate. The MPC will want to be sure that any such pickup is marginal and that pass-through to inflation remains low. We think they will be comfortable drawing this conclusion by August, though if inflation falls significantly below forecast, it is possible that the start date for rate cuts could come in June. Markets have certainly moved in this direction following today’s CPI data, with traders pricing in an additional half rate cut for 2024, reversing yesterday’s move to see three full cuts priced in. For sterling, the acceleration in BoE easing expectations is weighing on the pound, seeing GBPUSD fall four tenths, and GBPEUR three tenths, post release.

January’s CPI release leaves inflation tracking marginally below BoC forecasts, despite broad consensus expecting an overshoot in advance of the release



Nick Rees, FX Market Analyst


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