Can upcoming CPI justify BoE policy easing expectations in June?
Macro backdrop
Recent macroeconomic data for the UK economy have shown some softening in the labour market with the unemployment rate rising to 4.3% in Q1 2024 from 3.8% in October-December 2023. Wage growth remains elevated at 5.9%, which does not provide sufficient comfort for a rate easing.
Real rates turned positive starting in October 2023 and economic activity has since decelerated sharply, with Q4 2023 GDP contracting by 0.2% year-over-year.
Focus of the Week
The UK CPI release this week is likely to show a sharp deceleration in the headline figure, bringing it closer to the expected target. This would result in even higher real rates, potentially further dragging on sentiment, as has been observed since the Global Financial Crisis.
Inflation Drivers for April’s release
The April CPI is forecasted to be around 2.2%, down from 3.2% in March, with the consensus at 2.1%. A significant factor in this sharp decline is the announced reduction in the Ofgem price cap for energy prices. This 12% reduction in the cap is expected to lower both the electricity and gas price indices.
A gradual slowdown in inflationary pressures is also evident from high-frequency debit and credit card spending, which are key indicators of economic sentiment and inflation trends.
'Delayable' spending currently at ~75 (with pre-COVID levels set at 100) is significantly lower than the average of 88 seen in 2021 and 2022, even after accounting for seasonality. The higher levels in 2021 and 2022 reflected greater confidence in the economic situation, supporting discretionary spending and contributing to demand-led inflation.
Conversely, 'staples' spending had remained elevated in 2021 and 2022, indicating sustained cost pressures, particularly in food and energy prices. The current level at 113 can also be an indicator of ‘staples’ impinging on ‘delayable’ spends amidst the economic slowdown.
Indicio model forecasting for CPI
Taking into account multiple hard data points, soft survey lead indicators, and high-frequency alternative data related to wage growth, consumer confidence, and cost price pressures, we run several multivariate models on the underlying data to forecast CPI. The individual estimates from the various models range from 1.65% to 3.5%.
We consider the top three models evaluated for having the lowest RMSE (Root Mean Square Error) measurements. An accuracy-based weighting assigned to these top three models predicts a CPI release of 2.2% for April 2024. The sharp drop in Ofgem prices helps bring the headline CPI closer to the expected target. However, the reversal of base effects in H2 2024 keeps the market skeptical. This skepticism is reflected in the yield curve at the shorter end where 1-year and 2-year yields, though inverted, remain elevated.
