United Kingdom: Energy shock keeps risks elevated – Rabobank

Rabobank's Senior Macro Strategist Stefan Koopman notes UK headline CPI fell to 2.6% in June, below the MPC’s forecast, with broad-based downside surprises and easing domestic pressures. However, Koopman argues that renewed energy price increases and recurring shocks mean inflation is likely to move back above 3%, implying that 3% may effectively replace 2% as the UK’s de facto inflation norm over coming quarters.

From target undershoot to renewed pressures

"And Wednesday saw headline CPI inflation falling to 2.6% y/y in June, 0.5pp below the MPC’s April short-term forecast of 3.1%. The downside surprise was broad-based across food, core goods and services, with a particularly notable contribution from food price inflation, which has slowed to just 1.7% y/y. While this was the lowest reading in 15 months, we expect inflation to return to 3%+ soon."

"After a brief pause, energy markets have again become a central risk to the inflation outlook. Crude oil prices have surged following the collapse of the US-Iran ceasefire and renewed disruption to shipping through the Strait of Hormuz. Ukrainian attacks on Russian refining capacity have added further pressure by tightening global diesel and refined product markets."

"The longer elevated energy prices persist, the greater the risk of second-round effects in price and wage-setting. And even if energy prices stabilise and fail to rise further, this will remain a key focus for policymakers in the months ahead."

"The MPC warned in June that the risks to its energy-price outlook were skewed to the upside. We agreed, seeing the MoU as fragile and easily undone."

"We expect the MPC to revisit its energy assumptions and, as in April, present alternative scenarios to show the potential inflation impact of a prolonged supply shock. The risk is that this creates more noise than signal."