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UK inflation bounces back, charting a course to 2% - ING

James Smith, a Developed Markets economist at ING, believes that the UK inflation is set to rise above 2% this year but is more likely to drift lower in 2022, suggesting the pressure on the Bank of England (BoE) to tighten policy again will be fairly modest.

"UK inflation bounced back to 0.7% in March, after a series of quirks caused an outsized slowdown in headline CPI to 0.4% in February."

"More importantly, though, this is really the last reading where we are comparing current prices to pre-pandemic levels. From next month, we’ll likely see the rate of CPI more-or-less double. Partly this reflects the slump in energy prices this time last year, but more recently we’ve also had a sharp 9% rise in the household energy cap. These factors, combined with the ongoing cost rises associated with global shipping and Brexit, are likely to push headline inflation above 2% later in the year."

"What matters for policymakers, however, is whether this above-target stint lasts into 2022. And unlike the US, where we expect inflation to be relatively sticky above 2%, we think the UK story is likely to be less exciting."

"We’d also expect any demand-supply imbalances to be more reflected in services prices over coming months, given that this is where consumer resources are likely to be more heavily targeted. Will these sectors take the opportunity to lever up prices? There will undoubtedly be some examples of this, though in general the price of services tends to be much stickier than goods. Indeed, despite the damaging effect of the pandemic on the likes of consumer services, the rate of inflation hasn’t really noticeably slowed (if you strip out the effect of the VAT cut in hospitality)."

"For the Bank of England, all of this has two implications. The fact that inflation is likely to rise this year while the economic outlook is improving suggests little imminent need to look at negative interest rates. However, the less exciting inflation story for 2022 suggests policymakers will be in little rush to tighten policy, which we don’t expect to happen before 2023."

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