After last month’s 3.1% print for UK CPI caused Mervyn King to write a letter to the Chancellor, there was a bit of relief today as it fell back to 2.8%, in line with the market’s forecasts. This is still higher than the Bank will be comfortable with, and inflation has now been above the 2% target level for a year. The “old” RPI number also fell back, from 4.8% in March to 4.5% in April. Food and non-alcoholic drinks prices remained strong, as did clothing costs. We’ve talked about this before, but it’s worth mentioning that milk prices are very strong at the moment – this is partly due to weak prices and discounting a year ago (this factor should persist until September), but in the medium term we have wider concerns about upwards pressure on agricultural produce. The high cost of oil makes biofuels more viable (especially as there are big subsidies to farmers to produce ethanol), which in turn makes corn prices rise for other uses (food for both humans and cattle feed), and also means that farmers are likely to turn land used by animals over to grain production – making the price of beef and milk rise too. Elsewhere, and more positively, the electricity price cuts are starting to feed through, and these reduced the CPI number by 0.2%.
Short dated gilts performed well this morning (yields down by 5 bps) , but the market still anticipates that we will get another rate hike in the next few months. Whilst Richard Woolnough (our corporate bond fund manager) thinks this is both inevitable and desirable, I’m a little more cautious. Wage settlements have continued to be subdued (and are below inflation, so real incomes look like they will fall for a second year), and the housing market (outside London at least) appears to be cooling down. Finally, we have had 3 rate hikes in the last year, and the full impact has yet to be felt (monetary policy typically acts with a lag of up to a year), and with a large volume of expiring fixed rate mortgage deals having to be refinanced at higher levels, I fear that the UK consumer is only just starting to feel the pain. So I’m left worrying about both inflation and growth – not a nice place to be.