Great Graphic: Core Inflation in the UK and EMU

In trying to explain the UK's low inflation, Carney identified weakness in food and energy prices as the main culprit.  It sounds reasonable.  After all, the decline in commodity prices, including oil, is well known.   Consumer prices have not risen in the UK over the past year.

Carney's comment suggests looking at core inflation.  In the UK (and EMU) measure core inflation by excluding food, energy, tobacco and alcohol.  This Great Graphic, composed on Bloomberg shows the UK (white line) and euro area (yellow line) core inflation measures.  

In June, core inflation in the UK and EMU was the same, a 0.8% year-over-year increase.  The UK's July estimate will be released on August 18.   The eurozone has already reported a preliminary estimate of its July core inflation.  It rose to 1.0%, which matches last year's high.   

It is a little difficult to tell from the chart, but the UK core CPI is matching its cyclical low.   The eurozone's core inflation bottomed at 0.6% in January, March and April. 

Carney is wrong for playing down the zero headline inflation as a function of the decline in food and energy.  Core inflation in the UK rivals Japan for the lowest in among the high income countries.  It is true that wages appear to be increasing in the UK, but more work needs to be done to fully understand why.  Are all sectors seeing increased wages?  Are some sectors experiencing a skill shortage and must pay up to acquire the desired skills?  Are sectors with higher productivity seeing higher pay increases, or are all sectors?  The answers to these type of questions are important because they will indicate if the wage increases are truly inflationary. 

There is also another difference between the UK experience and the eurozone experience.  Since March 2013, sterling has appreciated by nearly 22% on a broad trade-weighted measure that the BOE tracks.  It is up about 6.4% in the past three months alone.  As of yesterday, it stood at its highest level since early 2008.  It appreciated 1.2% in July.  

Since March 2013, the BOE's trade-weighted index of the euro is off almost 10%.   It is flat over the last three months, and was down about 0.7% in July.   Leaving aside the weighting of the CPI baskets, the relative movement of sterling and euro on a trade-weighted basis is probably part of the explanation for what could be a divergence in core inflation measures. 

It is reasonable to suspect that some of the weakness in food and energy bleeds into the core measure of inflation.   However, it is not immediately clear why Carney is again warning that rates need to rise in the period ahead.  It is not the first time he has pushed this line only to seemingly retreat.   

Given that it is common for homeowner to have adjustable rate mortgages, which means rate hikes are passed through to the household considerably faster than in the US, for example, it makes sense that they are well aware that the next move in UK rates is higher.  Yet, unlike the US, eurozone and Japan, the UK does not have near-zero interest rate policy, and sterling's appreciation has done some of lifting that some at the BOE seem to be in a hurry to see. 

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