UK Inflation Rate Slips Below 2% Target

UK treasurers have heartened by the news that inflation as measured by the consumer price index (CPI) fell to 1.9% last month, dropping below the Bank of England’s (BoE) 2% target rate for the first time in five years.

The UK economy is currenly enjoying the benefits of a ‘virtuous cycle’, having avoided the worst effects of the general European post-financial crisis downturn. The sterling (GBP) devaluation that was engineered after the crisis first struck in 2007-08 enabled the economy to put in what in retrospect may be seen as a decent performance, with employment levels exceeding expectations through the double-dip recessionary period – and building the foundations for growth.

The positive news on inflation clearly underpins BoE governor Mark Carney’s recent statements on interest rate stability, and treasurers can look forward to the continuation of this situation for some time. The combination of low interest rates, a resilient currency and stock market and increasing fundamental strength will encourage companies to look more aggressively to the capital markets to finance new business development.

Historically, the UK has rarely provided a more attractive scenario for investment and borrowing. Today seems an especially auspicious time for finance teams to review their organisation’s outlook and capital requirements, and to adjust their activities accordingly.

 

Effect on Sterling

“Today’s reading was lower than expected, which of course triggered a sell off on the GBP,” said Jarratt Davis, head of forex at Smile Global Management. “But the real question is how does this weaker rate of inflation affect the currency in the medium term?

“This should be viewed as a real opportunity to buy the GBP back, because it doesn’t really change the outlook on in the short term. The overall bias is still very bullish and one price of data doesn’t change that.

“Inflation is clearly important, but we will need to see sustained reductions and a slew of other negative data before the Bank of England change their stance to further easing.”

Steve Wilkie, managing director of retirement specialists Responsible Life, commented: “For years, [Britons’] standard of living has been steadily dampened by fast-rising prices. Pensioners and those on a fixed income have been particularly hard-hit. So for the spending power-sapping menace of inflation to have been brought to heel is marvellous news for them.

“But it’s not all good news. Now CPI has dipped below the Bank of England’s 2% target for the first timesince 2009, the governor will be in no hurry to raise interest rates to more normal levels. His latest forward guidance hints that a rate rise is still some way off.

“So for those who rely on savings for income, today’s fall in inflation is a meaningless victory. With interest rates still at rock bottom, their cash savings are going nowhere in real terms.”

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