CPI inflation was 1.9% in March, a little below the 2% target.
Inflation is projected to dip further below 2% during the first half of the forecast period, largely reflecting lower expected retail energy prices.
In the medium term, building excess demand leads to a firming of domestic inflationary pressures and pushes inflation above the target.
4.1 Consumer price developments and the near-term outlook
After falling markedly over 2018, CPI inflation has been relatively stable at rates close to the target at the start of 2019. CPI inflation was 1.9% in March. It was also 1.9% in Q1 as a whole, marginally higher than the February 2019 forecast (Chart 4.1).
Inflation is expected to remain close to the target in the near term, with changes expected to be driven by energy price moves (Section 4.2). CPI inflation is expected to rise temporarily above the target in April, largely due to an increase in the Ofgem energy price cap which pushes up retail gas and electricity prices. CPI inflation is expected to dip below 2% in Q3 (Chart 4.2).
CPI inflation over the first half of the forecast is expected to be lower than projected in February, largely reflecting expected developments in retail energy prices. Wholesale gas and electricity prices have both fallen by around a third since the run-up to the February Report and that is expected to feed into retail prices. In addition, the 1½% appreciation of sterling since the February Report (Section 1) means that imported cost pressures — which are still judged to be pushing up inflation as a result of sterling’s previous referendum-related depreciation — ease slightly more rapidly than previously projected.
Over the rest of the forecast period, domestic cost pressures are expected to build (Section 4.3), pushing CPI inflation above the 2% target. Inflation expectations, which can influence wage and price-setting decisions, remain consistent with inflation being around the target in the medium term (Section 4.4).
CPI inflation is expected to remain close to the target in the coming months
CPI inflation and Bank staff’s near-term projectiona
- Sources: ONS and Bank calculations.
a The beige diamonds show Bank staff’s central projection for CPI inflation in January, February and March 2019 at the time of the February 2019 Inflation Report. The red diamonds show the current staff projection for April, May and June 2019. The bands on each side of the diamonds show the root mean squared error of the projections for CPI inflation one, two and three months ahead made since 2004.
CPI inflation is expected to dip further below the target in Q3
Contributions to CPI inflationa
- Sources: Bloomberg Finance L.P., Department for Business, Energy and Industrial Strategy, ONS and Bank calculations.
a Contributions to annual CPI inflation. Figures in parentheses are CPI basket weights in 2019 and may not sum to 100 due to rounding.
b Bank staff’s projection. Fuels and lubricants estimates use Department for Business, Energy and Industrial Strategy petrol price data for April 2019 and are then based on the May 2019 Inflation Report sterling oil futures curve, shown in Chart 4.3.
c Difference between CPI inflation and the other contributions identified in the chart.
4.2 Energy and import prices
Wholesale gas prices — which feed through into retail prices with a lag — have fallen by around a third since the February Report (Chart 4.3). Wholesale electricity prices have fallen by a similar amount. These wholesale prices represent an important part of retail energy companies’ costs and they are a key input to how Ofgem calculates the energy price cap that affects standard variable and pre-payment tariffs. Given the recent fall in wholesale costs, the cap — which is reviewed twice a year — is projected to fall in October, having risen in April, and that will feed into retail gas and electricity prices.
Sterling oil prices — which affect CPI inflation directly through their impact on petrol prices as well as indirectly through their impact on production and transport costs — have been volatile over the recent past, but are currently at a similar level to a year ago (Chart 4.3). The oil futures curve — on which the MPC’s forecasts are conditioned — is downward sloping. The projected contribution from fuel prices to CPI inflation further out is therefore a little lower than in February, when the futures curve was broadly flat.
Overall, the contribution of retail energy prices to CPI inflation is expected to fall in 2019, dragging on inflation by 0.2 percentage points in 2019 Q4.
Non-energy import prices
Higher import prices caused by sterling’s referendum-related depreciation (Chart 4.4) have pushed up CPI inflation in recent years. Pass-through of that depreciation to CPI inflation appears to have been broadly in line with the MPC’s assumptions so far, although there is uncertainty about its precise extent and timing. For example, it is possible that pass-through occurred faster than had been anticipated, but then also fell back more quickly, such that import prices are now pushing up CPI inflation by less than currently estimated.
Annual import price inflation rose to 2.6% in 2018 Q4 (Chart 4.4), higher than expected in the February 2019 forecast. Import price inflation is projected to turn negative in 2019 Q4, however, partly reflecting the 1½% appreciation of sterling since February. The effect of import prices on CPI inflation is consequently expected to diminish, both in 2019 and further out (Section 5).
The outlook for inflation will continue to be sensitive to movements in the exchange rate. The sterling ERI has been volatile recently and has been sensitive to news related to Brexit (Section 1). Box 5 of the February 2019 Report sets out how the projections for growth and inflation could be sensitive to different exchange rate paths.
Sterling oil prices have risen since February, while wholesale gas prices have fallen
Sterling oil and wholesale gas prices
- Sources: Bank of England, Bloomberg Finance L.P., Eikon from Refinitiv and Bank calculations.
a Fifteen working day averages to 30 January and 24 April 2019 respectively.
b US dollar Brent forward prices for delivery in 10–25 days’ time converted into sterling.
c One-day forward price of UK natural gas.
Import price inflation fell back in 2017, but has been rising since
Import price and foreign export price inflationa
- Sources: Bank of England, CEIC, Eikon from Refinitiv, Eurostat, ONS and Bank calculations.
a The diamonds show Bank staff’s projections for 2019 Q1.
b Domestic currency non-oil export prices as defined in footnote d, divided by the sterling effective exchange rate index.
c UK goods and services import deflator excluding fuels and the impact of MTIC fraud.
d Domestic currency non-oil export prices of goods and services of 51 countries weighted according to their shares in UK imports. The sample excludes major oil exporters.
Monitoring the MPC’s key judgements
4.3 Domestic cost pressures
Developments in labour costs
Wage growth picked up during 2018. Four-quarter growth in whole-economy total pay is expected to have remained at 3.5% in 2019 Q1, some way above its post-crisis average of 1.9% (Table 4.B). Annual growth in regular pay — which excludes the volatile bonus component from total pay — is expected to have been similar. According to the Bank’s database, median pay settlements were around 3% over the year to March, similar to at the time of the February Report. April is an important month for settlements, however, and much of those data are still to come.
Pay is growing at its strongest sustained pace since 2008. Previous episodes where wage growth has picked up since the financial crisis have proved to be transitory. In mid-2015, for example, pay growth rose to 3.1%, but fell back to 1.9% by the end of the year. Part of the pickup in pay growth during 2018 reflects compositional effects, which will probably unwind at some stage. But the main driver has been the tightness in the labour market, which is likely to persist (Section 3).
Survey data point to continued solid wage growth in the near term. Expected pay growth picked up in 2019 Q1 in the CBI surveys. According to the REC survey, pay growth for new recruits fell back slightly in 2019 Q1, but the survey still suggests that wage growth will stay close to current rates. Intelligence from the Bank’s Agents suggests that wage growth was robust but levelling off. The Agents’ contacts reported that companies with a high proportion of low-paid staff concentrated pay increases on employees who were on or just above the National Living Wage, which rose to £8.21 in April.
The extent to which the cost of labour affects companies’ production costs per unit of output depends on how it is growing relative to productivity. Unit labour costs (ULCs) can be volatile, but they have accelerated in recent quarters and grew by 2.8% in the year to 2018 Q4, as wage growth has strengthened and productivity growth has weakened (Chart 4.5). Monthly data suggest that ULC growth fell back slightly to 2.6% in 2019 Q1. Growth in private sector unit wage costs based on the AWE measure of pay was similar. These rates are above historical averages.
In the MPC’s central projection, unit labour cost growth is expected to remain robust and to contribute to a gradual building of domestic inflationary pressures (Section 5).
Other measures of domestically generated inflation
Non-wage indicators of domestically generated inflation (DGI) have generally been stable in recent quarters (Chart 4.6), but remain weak relative to ULC growth. In particular, core services CPI inflation remains some way below its pre-crisis average of around 3½%. This is an important measure because it focuses on a subset of the CPI basket which is largely domestically produced, as well as excluding some volatile components such as food and energy prices. Core services CPI inflation has been depressed by particular weakness in a small number of components, notably rents and insurance, but nonetheless continues to paint a relatively muted picture of domestic inflationary pressures.
The weakness of core services CPI could be linked to the same factors that caused the sterling depreciation around the time of the referendum. The depreciation may have partly reflected a judgement by financial markets that UK businesses selling tradable goods and services would be less competitive in future. That would be expected to raise the price of tradable goods and services relative to non-tradable ones. Some of that adjustment could have happened through lower inflation among the non-tradable components included in core services CPI, as well as through higher inflation among tradable components that are not.1
The pickup in the growth rate of labour and other production costs and the fall in CPI inflation might suggest that companies’ margins in the consumer goods and services sectors have been squeezed. Margins are difficult to measure, but Bank staff’s indicator of profit margins among companies producing consumer goods has fallen back from its late-2015 high (Chart 4.7). The profit share — another proxy for companies’ margins — has also fallen slightly in recent years. The Bank’s Agents’ score for profit margins fell in 2017, although this has since partially reversed to around its series average.
1. For more details, see Tenreyro, S (2019), ‘The elusive supply potential: monetary policy in times of uncertainty’.
Pay growth has strengthened over the past year
Indicators of pay growth
- Sources: Bank of England, CBI, Chartered Institute of Personnel and Development (CIPD), KPMG/REC/IHS Markit, ONS and Bank calculations.
(a) Quarterly averages.
(b) Three-month average growth on the same period a year earlier. Figures for 2019 Q1 are Bank staff’s projections, based on data to February.
(c) Total pay excluding bonuses and arrears of pay.
(d) Measures of expected pay for the year ahead. Produced by weighting together responses for manufacturing, distributive trades, business/consumer/professional services and financial services using employee job shares. Data for financial services only available since 2009 Q1, and other sectors since 2008 Q2.
(e) Quarterly averages for manufacturing and services weighted together using employee job shares. The scores refer to companies’ labour costs over the past three months compared with the same period a year earlier. Scores of -5 and 5 represent rapidly falling and rapidly rising costs respectively, with zero representing no change.
(f) Pay increase intentions excluding bonuses over the coming year. Data only available since 2012.
(g) Quarterly averages for the pay of permanent and temporary new placements weighted together using LFS employee job shares. A reading above 50 indicates growth on the previous month and below 50 indicates a decrease.
Unit labour cost growth has picked up
Four-quarter unit labour and unit wage cost growth
- Sources: ONS and Bank calculations.
a Private sector wage costs divided by private sector output, based on the backcast of the final estimate of private sector output. The diamond shows Bank staff’s projection for 2019 Q1.
b Whole-economy labour costs divided by real GDP, based on the backcast of the final estimate of GDP. The diamond shows Bank staff’s projection for 2019 Q1.
Core services CPI inflation remains subdued relative to the past decade
Indicators of domestically generated inflation
- Sources: ONS and Bank calculations.
a Quarterly averages of monthly data. Excludes airfares, package holidays, education and VAT; where Bank staff have adjusted for the rate of VAT there is uncertainty around the precise impact of those changes.
b Includes the GDP deflator (to 2018 Q4), GVA deflator excluding the government sector (to 2018 Q4) and services PPI (to 2019 Q1).
Some indicators suggest that margins have fallen in recent years
Indicators of companies’ margins
- Sources: ONS and Bank calculations.
a Calculated as differences in the ratio of the CPI, seasonally adjusted by Bank staff, and estimated costs of production and distribution for consumer goods and services, consisting of labour, imports, energy and taxes, weighted to reflect their intensity in CPI. Difference from average since 2000.
b Quarterly averages of scores for margins in the manufacturing and services sectors weighted together using output shares.
c Private non-financial corporations’ gross trading profits as a share of GVA at factor cost. Difference from average since 2000.
4.4 Inflation expectations
The MPC monitors a range of indicators of inflation expectations — derived from financial market prices and surveys of households and companies — to assess whether they remain consistent with the target.
Inflation expectations among households, companies and professional forecasters have given mixed signals recently. Household inflation expectations were little changed in the latest quarter, although there has been some upward drift in the short-term measures over the past year. Companies’ inflation expectations fell in the latest data, although these have been somewhat volatile in the past. The medium-term projections of professional forecasters fell slightly to 1.8% in 2019 Q2 (Table 4.C).
Measures of inflation expectations derived from financial market indicators increased in 2018 H2. Financial market inflation expectations at the one-year horizon have fallen back a little since, but longer-term measures have risen a little further (Table 4.C). This is in contrast to inflation expectations in the US and euro area, which have fallen over the past year.
Overall, the MPC judges that inflation expectations remain anchored. The MPC will continue to monitor measures of expectations closely.
Indicators of inflation expectationsa
- Sources: Bank of England, Barclays Capital, Bloomberg Finance L.P., CBI (all rights reserved), Citigroup, GfK, ONS, TNS, YouGov and Bank calculations.
a Data are not seasonally adjusted.
b Averages from 2000, or start of series, to 2007. Financial markets data start in October 2004, YouGov/Citigroup data start in November 2005 and professional forecasters data start in 2006 Q2.
c Financial markets data are averages to 24 April 2019. YouGov/Citigroup data are for April.
d The household surveys ask about expected changes in prices but do not reference a specific price index. The measures are based on the median estimated price change.
e In 2016 Q1, the survey provider changed from GfK to TNS.
f CBI data for the distributive trade sector. Companies are asked about the expected percentage price change over the coming 12 months and the following 12 months in the markets in which they compete. The 2018 Q1 data point was pushed up significantly by one response.
g Instantaneous RPI inflation one and three years ahead and five-year RPI inflation five years ahead, implied from swaps.
h Bank’s survey of external forecasters, inflation rate three years ahead.