UK Inflation Signals Provide Mixed Picture Ahead of Winter

The Bank of England's (BoE) reaction function to inflation is being closely watched, and recent data has provided some mixed signals. Despite higher energy prices and a softer labour market, alternative measures of inflation show that momentum and persistence are not as strong as previously thought.

One measure, the Inflation Shock Momentum Index (ISMI), shows that broad momentum has been flagging, with no sustained additional upward supply shock materializing. The common component across CPI categories, estimated by the Office for National Statistics (ONS), suggests that inflation persistence is receding rather than worsening.

The BoE's Decision Makers Panel (DMP) survey provides another perspective on second-round effects and expectations. While realised and expected wages continue to decline, suggesting receding rather than increasing feed-through, firms' 'expected own prices' have actually levelled out at still elevated levels around 4%. This is a less reassuring angle on the risks to the longer inflation outlook.

The BoE remains in its majority 'wait-and-see' mode for now, balancing the risks of inflation and downside growth. The crunch point will come in the winter, when risk sentiment may be fragile and growth is weakening. If this happens, the Bank may stick to its view that tightening to date can be sufficient.