UK inflation hedged up and unemployment rate improved

Inflation in the UK climbed by 2.9% y/y in December, scaling 1% more than in November. This sharp increase was due to 1) the base effect in energy prices; 2) the reversion of last year’s temporary VAT reduction; 3) the decline in Sterling. The reversion of last year’s VAT reduction and the Sterling’s depreciation are likely to push up prices again in January. However, the effect of the former is highly uncertain, since it depends on how retailers will respond. With consumer spending still weak, the possibility of raising prices is limited. Inflation may surpass 3% in January, consequently calling for the BoE Governor to report to the Chancellor explaining the reasons for the increase of the CPI above the inflation target (2% with a 1% tolerance). With inflation expected to weaken throughout the year as spare capacity continues to put downward pressure on inflation, we believe that the BoE will not change its monetary policy stance in the short term.

The UK unemployment rate fell at its fastest pace since April 2007 as the economy showed signs of emerging from its worst recession on record: the widely-watched claimant count measure of unemployment in December fell by 15,200, much larger than the 4,600 decline forecasted by the consensus. The 7.8% UK jobless rate swam underneath the 10% figure submerging both the USA and the Euro zone. The trend towards more favorable employment conditions is likely to continue in the next few months, though at a very slow pace. Indeed, the UK’s economy is likely to exit from recession in Q4 and grow at a very moderate pace throughout 2010.