UK Stagflation Worsens Materially As Inflation Jumps To Highest Since 2008, Deficit Surges

More bad news out of the UK, where CPI inflation surged from an already nosebleed inducing 4% to 4.4% in February coupled with deteriorating budget shortfalls as public borrowing was nearly double the consensus. The inflation number is particularly worrisome as it was the highest since 2008, driven by a surge in clothing price inflation. It seems at least UK retailers have reached their margin breaking point and have no choice but to hike end prices at this point. From Goldman: "CPI inflation rose from 4.0%yoy to 4.4%yoy in February (vs. Cons. and GS: 4.2%). This is the highest rate of inflation since 2008 and was driven by a sharp increase in clothing price inflation (from 1.3%yoy to 2.8%yoy). The public-sector borrowing data were disappointing on the month (£10.3bn vs. Cons: £8.0bn, GS: £4.3bn) but that overshoot relative to consensus expectations was almost entirely offset by (net) downward revisions to previous months' data."

More from Goldman Sachs:

1. The transport component of the CPI was the largest contributor to the rate of year-on-year inflation in February, adding 1.3%pts to headline inflation. Within this, the significant drivers were fuels and lubricants, the prices of which rose by around 16%yoy. The increase in the year-on-year rate of inflation in February, from 4.0% to 4.4%, was driven both by the 'clothing and footwear' and 'housing and household services' components (with gas bills making the largest upward contribution in the latter). Together, these two categories contributed more than half of the 0.4%pt increase in inflation between January and February.

2. The increase in VAT at the start of this year will continue to have a base effect on inflation through the duration of 2011. Combined with a rising contribution from commodity and food prices, we expect CPI inflation to peak in the coming months but to remain close to 4% throughout 2011. Over the medium-term, downward base effects from recent energy price increases kick in only at the tail-end of this year, allowing a decline in headline inflation to around 3% by December. These downward forces are then likely to be amplified by base effects in early 2012 (from the January VAT increase) and extended through the first half of next year. We will send out an updated inflation path later today.

3. There is a high level of disagreement within the MPC as to how much of a danger recent inflation readings pose. While the median voter on the committee remains wary of attaching too much weight to spot inflation, we learned from the February minutes that "of those members not favouring a rise, some thought the case for an increase had grown". This morning's CPI print, and its implication for near-term inflation dynamics, is likely only to add fuel to the fire of this debate.

4. Also released this morning, headline public-sector borrowing (i.e., including financial interventions) overshot consensus expectations by around £2½bn in February. This was almost entirely offset, however, by cumulative revisions to the PSNB over the ten months of this financial year. On the PSNB measure excluding financial interventions, borrowing came in £4½bn higher than expected on the month; the effect of revisions to prior months lowered the cumulative 'PSNB ex.' by £1.3bn. The growth of tax receipts edged lower in February but remains consistent with nominal GDP growth of around 4%yoy (Chart 1).

5. Tomorrow's Budget is unlikely to provide any major surprises, principally because the government has already set out its fiscal plans for the duration of parliament in some detail. Two key things to watch will be the downward revision to the OBR's 2011 growth forecast (previously 2.1%) - a mechanical consequence of the weak Q4 GDP data - and the new deficit forecasts (likely to be revised down for 2010/11 but revised higher for future years, partly as a result of weaker GDP growth in 2011).


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