U.K. inflation dips below zero

Since January 2014, U.K. inflation has consistently ben below 2% y/y. For the whole of this year, it has been close to zero. Inflation will remain very low in the short term, but for the setting of monetary policy, the medium term outlook is key.

As the BoE writes, medium-term inflation depends on "the balance of two opposing forces: the extent to which domestic costs pressures built, set against any persisting external disinflationary pressure."

The current pace of wage increases around 3% y/y could be compatible with inflation close to the 2% target or just slightly below, if sterling had not appreciated significantly since mid-2013. Without an increase in unit labour costs, inflation will probably not return to target any time soon. 

"If external downside risks to the economic outlook actually materialise and the labour market weakens as a consequence, the BoE will probably remain on hold for longer. The BoE's next inflation report due on 5 November should be read carefully. We stick to our view that a process of gradual rate increases will start in the first quarter of next year", says Nordea Bank.