News | Question of the Week, WC 16th July
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Question of the Week
Q. Was June’s downside inflation surprise simply due to U.K. clothing retailers starting their summer sales earlier than usual?
A. CPI inflation held steady at 2.4% in June, undershooting both the consensus, 2.6%, and the MPC’s 2.5% forecast. The downside surprise was entirely due to core inflation, which dropped to 1.9%—its first sub-2% reading since March 2017—from 2.1% in May. In turn, a plunge in clothing inflation to 0.4%, from 1.5%, accounted for most of the decline in core inflation.
The recorded rate of inflation in many sectors is sensitive to the timing of Index Day, the day of the month when the ONS collects its data. Index Day always is either the second or third Tuesday of the month. If Index Day was the third Tuesday last month but the second Tuesday in June 2017, clothing inflation would fall, because clothing retailers usually start their summer sales mid-way through the month. But Index Day was the second Tuesday of June in both 2018 and 2017, so the fall in clothing inflation isn't just statistical noise.
Clothing inflation might have dropped if a larger proportion of retailers than last year already had begun to discount their goods by Index Day. But we can find no concrete evidence to support this conclusion. Warmer-than-normal weather meant that demand for clothing in the run-up to the sales period had been strong. Sales volumes jumped by 1.0% month-to-month in April and by a further 1.9% in May, so retailers shouldn't have had much excess stock to shift. Indeed, the balance of retailers reporting that stock levels were above normal in early June was one-third lower than a year earlier, according to the E.C.’s Economic Sentiment survey.
Instead, it seems that the sharp fall in clothing inflation is a sustainable downshift in response to recent weakness in import prices. Our chart below shows that clothing import prices fell 1.9% year-over-year in April. The year-over-year rate turned negative as long ago as October 2017, and it points to clothing inflation remaining close to zero over the next six months.
June’s official retail sales data also provide a useful cross-check. The clothing price deflator eased to 0.6% year-over-year, from 1.5% in May. Unlike the CPI figures, the retail sales data are collected across the entire month, so they will be less sensitive to precise day retailers started to run promotions.
Accordingly, clothing inflation likely won’t rebound significantly in July and it should continue to fall sharply over the second half of this year. We expect the headline rate of inflation to fall back to 2.0% by the end of this year and then to slip below the target in early 2019.
The MPC, however, always has emphasized the medium-term outlook for inflation, rather than its current rate, when it has made the case for higher interest rates. It still thinks that the economy is growing at an above-trend rate, that spare capacity has been used up, and that wage growth will firm up in response to ultra-low unemployment. Accordingly, June’s inflation data likely won’t dissuade the Committee from raising Bank Rate at its next meeting on August 2.
Samuel Tombs, Chief U.K. Economist, Pantheon Macroeconomics
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Posted: 19th Jul 2018
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