Munshi Ahmed/Bloomberg

Slumping Oil Isn't All Bad for U.K. Inflation. No Really.

The weaker pound and spending boost are also important

At first glance, the latest drop in oil prices spells bad news for the Bank of England's inflation forecasts. 

The investor outlook for Brent crude in December 2018 is now $46 a barrel, well below the $62 that the BOE used to underpin its outlook in November. You'd think this would dash officials' hopes of consumer-price growth climbing back to the 2 percent goal by 2017 and also pour water on the prospect of a rate increase any time soon.

But there's more to it than that.

Exhibit A: The pound's 6 percent drop against the dollar in the second half of 2015. Brent futures are priced in dollars, but buying oil in cheaper sterling may mean the lowflation impact of weaker crude won't be so bad, according to Samuel Tombs of Pantheon Macroeconomics in London.

Exhibit B: Household spending. While the oil-price drop may prompt the central bank to cut its near-term inflation forecast, projections for later years -- the ones that matter for setting monetary policy -- could stay unchanged or be raised. That's right, raised.

Cheaper energy puts more money in consumers' pockets, and that could boost spending and hence bolster prices. 

"The revisions to the inflation forecast may not be as big as you might expect given the fall in the oil price," Tombs said. "If anything the BOE might assume that by boosting real incomes spare capacity will be reduced and in the medium term inflation might be a bit stronger."

And that might support the case for a rate increase this year after all. 

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