UK Economic Update – 22 August 2015

Two members of the Monetary Policy Committees voting committee capitulated, broke ranks and voted for an increase in interest rates at the most recent meeting, according to minutes released this week. Despite the significance of the voting actions, the impact upon both sterling as well as the London stock market was muted in the aftermath of a surprise (to some) reduction in inflation for the month of July.

In detail, both Martin Weale and Ian McCafferty voted to increase the benchmark rate from 0.5% to 0.75%, indicating that when the time for an initial rise does come; increases in increments of 25 bp are not outside the realm of possibility.  

Nevertheless, the policy maker action was overshadowed by Tuesday morning’s inflation figures. These showed CPI slipping from 1.9% in June, down to just 1.6%. This was against official projections for a more measured reduction to 1.8%.

The main culprits behind the deceleration were falling clothes sales as well as further reductions to the prices of food, non alcoholic drinks and alcoholic drinks (spirits). While some of this reduction represents seasonal trends, such as the decline in clothing, there are others which are the result of structural changes at the industry level.

Most notably, fierce competition and price wars in the supermarket space has led to a sustained period of deflation in UK food prices, much to the delight of the British public. This combination of lower prices and lower volumes across both foods as well as clothing was the single greatest driver behind disappointing Retail Sales data for July, which was released on Thursday.

The apparent resumption of a downward trajectory in price pressures comes just a short time after currency, fixed income and equity investors had began to position for the possibility that the first increase to the base rate could be revised forwards into 2014.

While we doubt that weaker inflation will prevent policy makers from raising rates in the new year, we do believe that the week’s data has now dispersed with the risk of BOE/MPC action in 2014.

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