SOFTER INFLATION EXPECTATIONS EXTEND QE HEADROOM

• After rising for three consecutive months, our Consumer Barometer indicates that inflation expectations among UK households fell back a little in May. Given the sharper-than-expected decline in head line CPI inflation in April, this development offers a little more leeway to the MPC to undertake further QE over the coming months.  
• The sharp pickups in both job security and job prospects over 2012Q1 have petered out during April and May. This suggests that the improvements in employment and unemployment during Q1 are unlikely to be sustained over the next few months.  

EASING INFLATION EXPECTATIONS OFFER A LITTLE MORE QE HEADROOM  

After rising for three consecutive months to its highest level since last September, inflation expectations, as measured by the net balance of households anticipating higher prices over the next year, fell back to 70% in May from 75% in April. Given a larger-than-expected decline in CPI inflation from 3.5% in March to 3.0% in April, this fallback in expected price pressures, if it continues, offers a little more leeway for the MPC to undertake further QE before the end of the year.

However, it is important to note that despite the decline in headline inflation since last September, when it peaked at 5.2%, expectations remain elevated compared to recent months. This suggests that the underlying pressures on prices may not have softened to the extent suggested by the headline figure. Indeed, some of the 0.5pp decline in CPI inflation during April reflected base effects from the timing of Easter. It is also worth mentioning that while interest rate expectations for the next year declined in the immediate run-up to the last bout of QE, which began in February, they have been broadly stable over the last three months (chart B). This implies that households believe that the MPC are adopting a “wait and see” approach to monetary policy compared with earlier in the year.

IS THE RECENT STRENGTH OF LABOUR MARKET SUSTAINABLE?  

Despite the relapse of the economy into a technical recession during 2012Q1, and ongoing headwinds from the euro area, the labour market appears to be fairly resilient with the latest data signalling that employment rose by 105k in the three months to March while ILO unemployment fell by 45k over the same period with the rate declining to 8.2%. Meanwhile, the claimant count declined for the second consecutive month in April.

However, there are signs that these developments may be temporary. For example, the number of job vacancies has fallen by 7k since January and, at 457k in April, stands at its lowest level since last July. Both our sentiment indices, for job security and job prospects, anticipated the Q1 improvements in the headline indicators. However, the more recent outturns, for April and May, have been far softer, which suggests that these labour market gains are set to slow over the coming months (chart C). For example, the average monthly improvement of the job security net balance over the first three months of the year stood at 4 percentage points (pp). However this has slowed to 2.5 points per month during April and May. The job prospects balance paints an even more stark picture. The balance rose by an average of 5.7pp during Q1, but has been basically flat during March and April. Moreover, despite the improvement in Q1, both indices remain close to their pre-recession levels (chart D).

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