UK Inflation Preview: Tame inflation keeps Bank of England on a one-rate-hike-a-year path

• The headline UK inflation is expected to decelerate to 2.0% y/y in January hitting the Bank of England inflation target.
• Beyond short-term inflation the taming effect of lower oil prices, domestic price pressures are building up keeping the expectations above the target.
• The core UK inflation is expected to remain stable at 1.9% y/y.
• Sterling is unlikely to see much inflation driven movement as Brexit headlines dominate the market.

The Headline UK consumer price index (CPI) is expected to decelerate to 2.0% over the year in January, off 2.1% in the previous month while core inflation stripping the consumer basket off the energy and food prices is seen unchanged at 1.9% y/y, the Office for National Statistics (ONS) is expected to report on Wednesday, February 13 at 8:30 GMT.

While the short-term, inflation expectations are primarily driven by the oil price development that saw a massive decline in prices over the fourth quarter last year that is affecting the current rate of inflation now, the long-term effects are expected to remain on the upside. Especially the tight labor market conditions affect the long-term inflation expectations with pay raises behind the wage pressures.

“CPI inflation has declined and is it is projected to fall below the MPC’s 2% target over much of 2019, partly reflecting a decrease in petrol prices. CPI inflation is then judged likely to rise above the target as domestic inflationary pressures build It is projected to be a little higher than in November over much of the third year of the forecast period, reflecting the greater degree of excess demand. The risks around the inflation projection remain balanced,” the Bank of England wrote in the February Inflation report.

Among other factors influencing the UK headline inflation is the currency market development with substantial Sterling depreciation eventually pressing on higher import prices and higher inflation. Sterling exchange rate is unlikely to have a material effect on UK inflation in January even with the the short-term abrupt depreciation on January 2, when Sterling fell to a fresh 2019 low of 1.2438 against the US Dollar.

Even as the currency markets are unlikely to be directly influenced by the UK inflation data, traders should be aware that the substantial short-term deviation from the market consensus on the downside together with the unresolved Brexit deal could weigh on Sterling with depreciation tendency.

January headline and core inflation data from the ONS is expected to remain in the shadow of Brexit developments with the UK Prime Minister Theresa May working her way through parliament with the Brexit deal that will eventually pass and keep the UK on track for leaving the European Union in an orderly manner.

Disorderly Brexit would have a detrimental effect on Sterling and eventually on the UK inflation and monetary policy derailing the Bank of England from its one rate-hike-a-year policy outlook.