So What Next For Inflation ...

China’s headline consumer price index fell 0.3% year-on-year in July to register deflation for the first time in two years. This presents the opposite problem to that faced by major central banks in the West including the Bank of England.

“Persistent deflation in China would likely spill over to developed markets, as a weaker yuan and an high inventory levels lower the cost of Chinese goods abroad,” said Pimco economists in CNBC this week.

A deflation spillover into the West? Well not just yet. In the U.K. Inflation CPI basis slowed to 6.8% in July from 7.9% prior month. CPI(g) goods inflation slowed to 6.1% from 8.5%. CPI(s) Service Sector inflation moved slightly higher to 7.4% from 7.2%. Core inflation eased to 6.8% from 6.9%.

An element of deflation in manufacturing prices exist. Manufacturing output prices PPOs fell to -0.8% from 0.3%. Manufacturing input costs also fell to -3.3% from -2.9%. The fall in prices was largely fueled by the drop in oil prices.

Oil prices Brent crude averaged $112 dollars in July last year, compared to $80 dollars this year. This is a -33% inflationary impact £ Sterling adjusted.

We expect the oil price comparisons to ease through to the end of the year. We forecast oil prices to average $ 82 dollars in the third quarter and $84 in the final quarter Q4.

Manufacturing input costs are volatile. The pass through rates are roughly 50% from PPIs (input prices) to PPOs (output prices). The pass through rates are roughly 70% from PPOs to CPI goods. CPI(g) accounts for roughly 50% of the total CPI index. This is why we expect inflation levels to ease this year, despite the strength of service sector inflation.

Major concerns persist about the high levels of service sector inflation and the strength of earnings and wage settlements. This may mean the inflation target of 2% will remain elusive in 2024.

We expect inflation to average 6.0% in Q3, easing to just under 5% perhaps by the end of the year. Our assumption is for one more 25 basis point rate rise in September. Higher rates for longer the guideline for scenario planning.

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