Market Outlook - BNP PARIBAS - Investment Services India

eceive roughly 60/40 weight within the category.
While both are contributing to the increase, it is the
second-hand car market that appears to be adding
the most. From November 2008 to December 2009,
second-hand car inflation rose from -12.5% y/y to
+15.8% y/y - a swing of nearly 30pp! New car
inflation increased by just over 2.5pp to 4.4% y/y
over the same period.
We spoke to the Office of National Statistics which
suggested that an important explanation is, ironically,
the impact of cost cutting by businesses. As
companies choose to keep their current fleet of
company vehicles rather than change them, a major
source of supply for the second-hand car market has
shrunk. We should not discount the impact of a weak
sterling, however, particularly for the new car market,
given the large proportion of foreign car marques in
the UK.
Crucially, the month-on-month change in secondhand
car prices has slumped recently, suggesting
this boost to headline inflation has been temporary.
Assuming this series reverts to around the seasonal
norm, and even after taking into account the January
VAT hike and a likely further VAT hike to 20%, we
estimate that car prices will subtract ½pp from
headline inflation over the next twelve months.
The exchange rate also appears likely to have played
an important part in explaining the strength of the
other two main contributors to core goods inflation
over the past year – clothing and audio-visual
equipment inflation – given their high import content.
Audio-visual equipment inflation has increased from
-13.5% y/y in November 2008 to -6.9% in the most
recent December release. That 7pp increase has
added a further 0.3pp to core inflation. Clothing price
inflation has risen by 3.6pp since November 2008 to
reach -3.5% in December, also adding 0.3pp to core
inflation over that period. However, unless the GBP
exchange rate resumes its fall (it has been largely
stable over the past six months) this boost will also
fade.
Conclusion
Persistent upward surprises in the CPI for at least the
last year raise genuine concerns about the prospects
for UK inflation. However, when we consider exactly
what has been driving inflation higher, the outlook is
less worrisome. It is tricky to distinguish, for example,
between a rise in clothing inflation because of the
exchange rate or an independent increase, say,
because retailers are increasing their margins.
Nonetheless, our analysis highlights a number of
useful observations that reduce the perniciousness of
the rise in core inflation. Core goods have driven the
rise in core inflation – something disproportionately
attributable to vehicle prices with the exchange
rates’s influence consistent with the strength in
clothing and audio visual equipment inflation.
Services inflation, in contrast, appears to be
responding to the downturn and should continue to
do so ahead.
Eoin O’Callaghan & Alan Clarke 29 January 2010
Market Mover
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