Sterling depreciation likely to drive sharper pace of price increase in UK

The pound sterling which has depreciated around 18 percent from its 2015 peak on a trade-weighted basis is likely to be the key driver of UK inflation outlook. Despite a rise in energy prices UK headline and core inflation surprised to the downside in August.

Data showed that annual CPI inflation held at 0.6 percent while the ‘core’ rate – excluding food, energy, alcohol and tobacco – also remained unchanged at a 1.3 percent y/y. The main downward surprise came from the absence of an upward push from imported clothing, footwear and furniture prices.

With a weaker sterling, upward pressure on costs are likely to feed through, with imported goods – including of energy products and food – likely to see marked price gains. That said, lower underlying cost pressures are likely to provide an offset owing to a slowing economy and the resulting reduction in labour market tightness. This will likely limit inflation’s overshoot relative to target.

"We expect CPI inflation to reach 1.3% by the end of 2016 and move through the BoE’s 2% target in Q2 2017. Relative to the BoE’s August projections, our forecast is for the overshoot of the 2% inflation target to come earlier and be larger in magnitude, before beginning to slowly drift back." said Lloyds Bank in a report.