Headline inflation was in line with market expectations at 2.0% y/y in June, the same pace as in May. In contrast, core inflation, which excludes volatile prices such as energy, food, alcohol, and tobacco, edged higher to 1.8% y/y from 1.7% y/y. Nevertheless, labour market data showed an upside surprise, defying the slowdown in the economy as wage growth accelerated to 3.6% y/y in May from 3.2% y/y, the fastest since July 2008. Looking at the latest inflation print, we believe policymakers still has room to tolerate a surge in wage growth.

However, the risk of inflation overshooting the Bank of England’s (BoE) target appears high on the cards in 2H2019 due to the recent weakening in the pound sterling on the back of rising prospects of a no-deal Brexit. Having said that, it is crucial for the next PM to avoid a messy and disorderly Brexit, as such an outcome may trigger a strong sell-off in the pound sterling, At this juncture, we foresee the BoE instituting a rate cut rather than a rate hike in its future monetary policy decision as we are pricing in a higher likelihood of a no-deal Brexit, added with moderating global growth.

• Headline inflation was in line with market expectations at 2.0% y/y in June, the same pace as in May. In contrast, core inflation, which excludes volatile prices such as energy, food, alcohol, and tobacco, edged higher to 1.8% y/y from 1.7% y/y. 2Q2019 inflation averages at 2.0% y/y, falling short of the central bank’s forecast of 2.1%.

• In June, food & non-alcoholic beverages rose faster by 1.6% y/y compared with 1.0% y/y in May, which had offset the slower transport (2.4% y/y from 2.8% y/y) and utilities prices (2.8% y/y versus 3.4% y/y). Besides, services inflation, a proxy for domestic demand, has slowed down to 2.5% y/y in June from 2.6% y/y in May.

• Nevertheless, labour market data showed an upside surprise, defying the slowdown in the economy. In May, unemployment rate remained steady at 3.8%, unchanged from the month prior while wage growth accelerated to 3.6% y/y in May from 3.2% y/y, the fastest wage growth since July 2008.

• Looking at the latest inflation print, we believe policymakers still has room to tolerate a surge in wage growth. With wage growth outpacing inflation, it will bode well for financially stretched households. However, we are of the view that any boost to consumer spending is likely to be tempered somewhat by a weakening consumer sentiment. In May, consumer confidence deteriorated to -10.5 points from -8.3 points in April.

• However, the risk of inflation overshooting the Bank of England’s (BoE) target appears high on the cards in 2H2019 due to the recent weakening in the pound sterling, recording a YTD decline of 1.6%. The downward pressure in the pound was driven by rising prospects of a no-deal Brexit after the front-runners for the next Britain’s prime minister (PM), Boris Johnson and Jeremy Hunt, both declared that the Northern Ireland backstop is “dead”.

• Having said that, it is crucial for the next PM to avoid a messy and disorderly Brexit, as such an outcome may trigger a strong sell-off in the pound sterling, which in our view can go as low as the 1.15 levels. This in turn can push inflation materially higher and it would cause a double whammy for the BoE. At this juncture, we foresee the BoE instituting a rate cut rather than a rate hike on its future monetary policy decision as we are pricing in a higher likelihood of a no-deal Brexit, added with moderating global growth.

Source: AmInvest Research - 18 Jul 2019