UK inflation surprises on the downside

Chris Scicluna
Emily Nicol

UK inflation surprises on the downside on lower goods pressures and base effects
Following yesterday’s downside surprise in the latest US inflation data, this morning’s equivalent UK figures similarly came in below expectations, albeit remaining very high by historical standards. In particular, the headline CPI rate moderated 0.4ppt from October’s peak to 10.7%Y/Y, 0.2ppt below the median forecast on the BBG survey. The drop in inflation was in part thanks to base effects with respect to petrol prices, which were unchanged on the month in contrast to the big rise over the same period a year ago. As a result, energy inflation slowed almost 3½ppt, albeit remaining eye-wateringly high at 55.6%Y/Y. Inflation of food, energy and tobacco moderated slightly too, down ½ppt to 12.7%Y/Y, albeit again thanks only to base effects, in this case associated with past movements in tobacco duty.

However, core inflation also slowed in November, down 0.2ppt from the series peak reached in each of the prior two months, to 6.3%Y/Y. In part, that reflected a further easing in second-hand car prices, which are now down 5.8%Y/Y. And with inflation of clothing and footwear moderating 1ppt to 7.5%Y/Y, overall inflation of non-energy industrial goods slowed for a second successive month to a ten-month low of 6.3%Y/Y. In contrast, services inflation was unchanged at 6.3%Y/Y, with increased pressures in restaurants broadly offset by an easing in hotels, and transport and recreational services.

Looking ahead, UK CPI inflation is likely to remain close to current levels in December and January. But base effects and lower pipeline pressures should help it fall back below 10%Y/Y in February. And while uncertainties remain high, and household energy prices will be hiked again in April to keep inflation in the UK significantly higher than in other major industrialised economies, we expect a steady downwards trend in the core component to be established, enabling the BoE to cease its tightening cycle by end-Q1.

BoJ Tankan points to subdued economic outlook at turn of the year
Despite the vast amount of information provided on Japan’s business conditions and economic and inflation outlooks, there was nothing in today’s BoJ Tankan survey to suggest that the BoJ will alter its ultra-accommodative policy stance at next week’s Policy Board meeting. Indeed, the survey was something of a mixed bag. Admittedly, sentiment among large non-manufacturers this quarter was supported by the government’s discounted travel scheme and relaxation of international travel restrictions. Indeed, the headline non-manufacturing DI increased a little further than expected, up 5pts to a pandemic high of 19 in Q4, with the respective index for hospitality services DI up 28pts. But this improvement looks set to prove short-lived, with firms expecting it to have more than fully reversed in Q1. Furthermore, large manufacturers were unsurprisingly less upbeat about conditions in Q4, with the respective DI down 1pt to a seven-quarter low of 7 – admittedly a touch better than expected too – and a further modest deterioration forecast at the start of the New Year too.

Despite the gloomier forecast, both manufacturers and non-manufacturers were still relatively optimistic about expected sales and profits growth this fiscal year. And while capex projections were revised slightly lower from three months ago, forecast investment growth of 15.2%Y/Y would be the strongest since 1990. Today’s machine orders figures were at face value more encouraging for the near-term capex outlook too, with core orders up 5.4%M/M in October, underpinned by a surge in orders placed by non-manufacturers (14.0%M/M). But orders placed by manufacturers fell again at the start of Q4 (-6½%M/M). And overall, the level of total orders in October was merely flat compared with the Q3 average.

Of course, a key source of concern for Japanese businesses reflects elevated input cost burdens, which in Q4 firms considered to be the highest since the early 1980s. And while the respective output price DIs trended to a record high too, they suggest that firms continued to absorb some of these extra costs. Indeed, firms still expect their own prices to cumulatively increase by just 4.3% over the coming five years, with large manufacturers forecasting a rise of just 3.1% over that period. And while firms expect “general inflation” to be 2.7% this year (an upwards revision of 0.1ppt from the last Tankan survey), they expect it to fall back to the BoJ’s 2% target in five years’ time. Moreover, this pickup largely reflected higher expectations of small firms, while large firms forecast inflation to fall back below target (to about 1½%) in three years’ time.

Euro area IP expected to start Q4 on the back foot
Today will bring euro area IP figures for October. Based on figures published by member states, including declines in Germany (-0.4%M/M), France (-2.6%M/M), Italy (-1.0%M/M), Spain (-0.4%M/M) and Ireland (-10.7%M/M), aggregate euro area production is expected to fall 1.8%M/M to leave it still almost 3½% higher than a year ago but ½% lower than the Q3 average. This morning also brought a modest upwards revision to Spain’s CPI estimates for November, with the EU-harmonised rate revised up by 0.1ppt to 6.7%Y/Y, albeit still representing a drop of 0.6ppt on the month and the lowest reading since January.

Fed to slow pace of tightening, but maintain a relatively hawkish stance on policy ahead
Of course, all eyes will be on the Fed’spolicy announcement this evening. Following yesterday’s downside surprise to November’s CPI estimate (please read the assessment of Daiwa America’s economists here), the FOMC seems bound to slow the pace of tightening this month to 50bps, which will take the Fed Funds Rate target range to 4.25-4.50%. But the Fed will continue to signal more tightening to come. And there will be great interest in the FOMC’s updated economic forecasts and dot-plot charts. The median expectation for the FFR for the end of next year will be revised higher from 4.50-4.75% in the previous projections published in September, possibly to as high as 5.00-5.25%. The dispersion of the dots in 2023 will also be closely watched, with a wide dispersion suggesting a high degree of uncertainty and therefore perhaps a lower probability of aggressive monetary policy action throughout the year. 

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