UK CPI: one swallow doesn't make a summer

UK CPI (February YoY) came in ahead of expectations at +3.2% versus consensus of +2.6%. The 10 year Gilt yield rose to 3.37%, up 24 basis points. Mervyn King commented this morning on the higher than expected inflation number in an open letter to the Chancellor:

"Since last summer, world commodity prices have fallen sharply and that has helped drive a fall in overall CPI inflation from 5.2% in September to 3.2% in February. But the effect on UK consumer prices of decreases in world prices has been dampened by the depreciation of sterling. Since my December letter, the sterling effective exchange rate has depreciated by about 5%, bringing the total depreciation to 28% since the summer of 2007. February's inflation out turn is somewhat higher than expected. That could reflect pass-through of the exchange rate depreciation to consumer prices since much of the strength in the out turn appears to be concentrated in components where a large share of goods is imported."

Later, when questioned by the Treasury Committee about the implications about the implications for the Bank's QE programme, Mervyn King commented:

"We might need to do less on QE than £75 billion if it works... the target is to complete something in the order of £75 billion in QE over the next three months"

However, one swallow doesn't make a summer and it is still premature to say whether monetary policy is working or if it is stoking inflation. Indeed, Mervyn King noted in a statement to the Treasury Committee this morning that inflation is likely to fall in the medium term:

"Inflation in the UK is currently still above target. CPI data released this morning show that inflation was 3.2% in February, triggering another open letter from me to the Chancellor. At its next meeting, the Committee will want to consider further the implications of this inflation out turn. But the sharp slowdown in spending is likely to generate a significant margin of spare capacity in the economy, which, in turn, will bear down on inflation in the medium term. So the key question for the MPC is how to ensure nominal demand returns to a level that is consistent with meeting the inflation target."