UK inflation cools off more than expected ahead of BoE meeting

UK inflation cooled off more than expected last month, but economists were divided over whether it would reduce the pressure on the Bank of England to raise interest rates ahead of the policy meeting this week.

February's consumer price index rose 2.7% compared to the same month last year, down from 3.0% a month earlier and lower than the market's expectation of 2.8%. CPI was up 0.4% month-on-month, which was also lower than the 0.5% average forecast from economists.

The fall was due to a decline in core CPI, which excludes more volatile prices such as fuel as food. The Office for National Statistics revealed core CPI eased off to 2.4% in February from 2.7% in January, again lower than the market consensus, which had pointed to 2.5%.

CPIH, the preferred measure of the ONS as it takes account of owner occupiers' housing costs, came in at 2.5% versus the 2.6% expected. The much maligned retail price index was up 3.6% year on year, down from 4.0% and below the 3.7% forecast.

Ahead of the BoE's monetary policy committee meeting this week, inflation came in well below the MPC's 2.9% forecast for the month, which may push the case for raising interest rates beyond many economists' and analysts' expectations of a May hike.

The drop in core inflation primarily reflected a plunge in services inflation to the lowest rate since last March, to 2.4% from 2.8% in January, partly was due to a drop in transport services inflation on the anniversary of big price rises last year.

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Inflation in labour-intensive sectors, like accommodation services, fell sharply too, which economist Samuel Tombs at Pantheon Macroeconomics said was an indication "that Britain still doesn’t have an underlying inflation problem".

With food inflation and core goods inflation both falling in February, Tombs said inflation in both of these sterling-sensitive sectors is likely to decline further over the coming months, given that import prices have held steady over the last nine months and retail surveys have signalled slower price rises ahead.

"The MPC probably wouldn’t change course if February’s CPI figures had been the only data to surprise to the downside. But since the MPC last met in February, GDP, labour market and retail sales data all have been weaker than the consensus anticipated, while the latest PMIs and the recent heavy snow suggest that Q1 GDP growth will undershoot the MPC’s forecast," Tombs added.

"Accordingly, we think that the MPC will refrain from ratcheting up its guidance and won’t clearly signal an imminent rate rise in the minutes of Thursday’s meeting, prompting markets to reassess their view that the chances of a May rate hike are as high as 80%."

Paul Hollingsworth at Capital Economics was in the other camp, saying "we don’t think that the CPI outcome significantly reduces the chance of an interest rate hike in May".

"For one thing, the ONS suggested that there may have been a temporary downward distortion related to the timing of Valentine’s Day, which boosted prices in the same month a year ago. Moreover, to the extent that higher inflation has been the biggest drag on household spending growth, the fact that it is fading quicker than expected should actually help the near-term growth outlook."

With Mark Carney and co focussing more on wage growth recently, if Wednesday's figures reveal another pick-up, as expected, Hollingsworth was confident the MPC will raise interest rates again at its meeting in May.

Chris Williamson at IHS Markit still saw enough in the economy to lead to a hike. Given other trends in the economy, he said the larger than expected drop in headline inflation "will do little to deter policymakers from raising interest rates".

He added: "The economy appears to be enjoying further steady growth in the first quarter, expanding at a rate at or above that deemed to be its long-term sustainable pace according to the Bank of England. Wages are rising and households are already braced for higher borrowing costs, with the majority (57%) anticipating another hike within the next six months and one in three expecting rates to rise in the next three months."

Adam Chester, an economist at Lloyds Bank, said while the MPC is likely to take some comfort from today's report, the slow reduction in inflation towards the 2.0% target and the Brexit transition deal agreed on Monday could mean the committee "may feel more comfortable raising interest rates over the coming months".

"Tomorrow’s labour market report will provide more colour on the extent to which wage pressures are building."