Swoffers Commercial

Issue Date – 15th November 2010
Introduction

This is the fourth quarter edition of ‘Inflation Outlook’: a Policy Council report providing forecasts for inflation. The forecasts are based on econometric models and provide a composite forecast of RPIX and RPI. These forecasts are revised and published on a quarterly basis in the month following the Policy Council’s publication of official Guernsey quarterly inflation rate and timed to follow the Bank of England’s quarterly inflation outlook .

NB – Forecasts are presented with statistical confidence (or error) bands (the shaded area). These represent the range of possible outcomes with (in this case) a 95% statistical certainty.

Headlines

• Rates of inflation remain lower than the UK mainland (as has been the case in Jersey). This is expected to continue into the final quarter.
• RPIX, the official headline rate, continues to be very benign at 2.3% in the third quarter, just 0.1% off forecast. We still expect a slight upward movement in the final quarter and for rates to gently increase in the first half of 2011 although staying close to the 3% target.
• RPI remains at very low levels in comparison to historic norms driven by lower house price inflation, that whilst positive in 2010, is at a more sustainable level than was seen in the years leading up to the financial crisis. We also expect RPI to drift higher over the coming quarters although remaining lower than RPIX .
• Once again the pressures on inflation are likely to arise from higher oil prices as many are forecasting oil to reach $100 barrel during 2011 led by the combined effect of increasing global demand and the weaker dollar.
• Once again, as per the last quarter, we anticipate both measures of inflation RPIX and RPI rise to gently towards the end of the year but absent any unforeseen circumstances, both measures should remain at ‘comfortable’ levels.
• The UK looks set to continue a steady expansion (the Bank of England assumes no double dip) and its expectation is for UK inflation to rise further in the short term.

Inflation Outlook

Figure 1: Forecast Guernsey RPIX

Figure 2: Forecast Guernsey RPI

Figure 3: Guernsey Infl ation Rates

Guernsey’s local inflation remains subdued. The annual rate of RPIX inflation, the offi cial preferred measure, stood at 2.3% at the end of the third quarter (as against a forecast of 2.4%) and this is expected to rise gently to around 2.7% in the fi nal quarter, remaining below target. Inflation in Guernsey has remained well below that of the UK mainland and this is anticipated to continue well into 2011. Whilst we are forecasting a gentle increase in inflation in the first half of 2011, this would still leave RPIX around its target level.

RPI is presently very low by recent historic standards (RPI averaged around four percent during the course of the last decade). This in part methodological: the housing component relates to mortgage payments which themselves are driven by recent historic averages of house prices. Whilst house price inflation has been positive during 2010, it was negative for much of 2009, and in any event is much below the average rates of the period 2006 to 2008 and thus its contribution is reduced; lowering the overall rate.

Figure 4: UK Inflation Rates

In the UK, the Bank of England expects the UK economy to avoid a double dip and has built in continued steady growth into its forecasts. It expects UK inflation to rise again from its present rates driven by various factors; not least in the New Year by VAT increases. One might expect continued adverse commentary as UK headline inflation rates look set to diverge from the rates seen in most western economies (including both the Channel Islands).

Clearly the VAT effect will be absent in the Channel Islands although in Guernsey we should expect a small contribution in the New Year, as happens every year, from rising duties. The market is expecting oil prices to drift higher into and beyond the New Year, with several analysts suggesting oil will hit $100 a barrel during 2011. This will put upward pressure on inflation albeit no more than that seen during the latter half of 2010.

Numerous commentators are expecting clothes prices to rise during 2011. Consumers in the UK have become used to ever decreasing (particularly in relative terms) prices of clothes and the experience in Guernsey is no different in this regard. However, many retailers have publicly warned over the last quarter that increasing demand for clothing commodities from the Far East (in particular cotton) is leading to increasing input prices that will soon need to be passed onto consumers.

Figure 5: Comparison of Infl ation Rates

The story is similar when it comes to exchange rates and import prices. Whilst Sterling is not appreciably weaker or stronger than a year earlier, the continuing effect on a sustained weaker Sterling (relative to the years prior to 2008) is that retailers are likely to seek to pass on increased costs as the UK economy continues recovering in 2011.

Overall the outlook for inflation continues to be relatively benign. Whilst rates are likely to rise gently these are from low levels and we are forecasting both rates of inflation to be between 3.0% and 3.5% by the summer of next year: levels that would be consistent with healthy economic conditions.

Further Information

Please contact Dr Andy Sloan (Economist) for further information.

Policy and Research Unit
Sir Charles Frossard House

La Charroterie
St Peter Port
Guernsey
GY1 1FH
Tel: (01481) 717296
Fax: (01481) 713787
e-mail: policy.research@gov.gg
web: www.gov.gg/pru