- UK sees deflation in July-August period
- Help Out to Eat Out a major contributor to declining prices
- Weak recovery likely to keep inflation subdued over coming weeks
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Falling demand for international travel and the Eat Out to Help Out scheme meant prices in the UK fell 0.4% between July and August, according to the ONS.
The -0.4% month-on-month reading dragged down the annual rate of inflation to just +0.2%, meaning prices are virtually unchanged on where they were in August 2019. The fall in annual inflation is significant, given that in July it stood at +1.0%.
The ONS says the price of catering services fell by 5.7% between July and August 2020, compared with a rise of 0.2% between the same two months in 2019. The ONS says the fall this year reflects the effect of the Eat Out to Help Out Scheme and, to a lesser extent, the reduction in Value Added Tax from 20% to 5% on the hospitality sector.
Yet the numbers were a little stronger than the market consensus was looking for, as a survey of economists showed expectations were set for -0.6% to be reported on a month-on-month basis while the annual rate was expected to come in at 0.1%.
And the core inflation rate - which removes volatile measures such as fuel - read at 0.90%, which is stronger than the market was looking for at 0.8%.
The data therefore beat expectations and should therefore be positive for Sterling exchange rates, however given that inflation remains so far below the Bank of England's 2.0% target it is unsurprising that the Pound shrugged at the release.
Indeed, some economists are saying that the Bank of England will likely have to ease monetary policy further over coming months as they face the prospect of a weak recovery and insipid inflation, a combination that tends to lend itself to weaker Pound exchange rates.
"The path for inflation in the next few months will depend on whether levels of consumer demand and business activity can be sustained. A tighter supply-demand balance will put upward pressure on prices. However, a weaker recovery, driven by lower consumer demand, could lead to a prolonged situation of low price growth, putting more pressure on the Bank of England to further ease monetary policy but cutting rates further, perhaps below zero," says Jing Teow, senior economist at PwC.
While the -0.4% confirms the UK fell into deflation in July-August, expectations are for inflation to recover into positive territory over coming weeks as the Eat Out to Help Out Scheme ended in August.
"The effect of the ‘Eat Out to Help Out’ scheme was apparent," says Teow. "Falling prices in restaurants and cafes contributed the biggest change to the monthly growth rate."
Elsewhere, travel had a sizeable impact on prices with demand for international travel resulting in no inflationary growth for an important component of the inflation basket.
"On the other hand, the restrictions also caused a shift to domestic travel, which contributed to a rise in the price of hotels, road transport services and second-hand cars in August, compared to July. Other categories, such as games, toys, and hobbies, also saw an increase in prices, as demand for indoor activities increased over the summer," says Teow.
"Crucially the biggest downward force on consumer prices – the month-long 'Eat out to help out' scheme – has now finished," says Richard Berry, founder of goodmoneyguide.com. "Nevertheless oil prices remain subdued and hopes that Christmas spending will speed up price growth in coming months remain far from assured."
Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics says prices should remain subdued over the remainder of 2020 and the Bank of England will feel it has the room to boost its quantitative easing programme.
Tombs expects electricity and natural gas prices will fall in October in response to Ofgem’s 7.5% reduction in the default tariff price cap and firms in the services sector will likely absorb higher Covid-19 related costs, rather than pass them on to consumers, in the face of lingering weakness in demand.
"Accordingly, we expect the headline rate of CPI inflation to average just 0.6% in the last four months of 2020, persuading the MPC to sign off more asset purchases before the end of this year," says Tombs.