promising deflation, but getting inflation

Commentators were "surprised" by today's inflation numbers. Before the ONS produced the May rate, the consensus was that the headline number was going to tumble to 2 percent, with some brave souls even suggesting 1.8 percent.

Instead, the May rate came in at 2.2 percent. Only 2.2 percent? Is it safe to conclude that inflation is beaten and that the UK economy is only an inch away from deflation? Sorry, today's number offers no such comfort.

Take a look at the monthly inflation rates. From October to January, the CPI was falling in absolute terms, largely because of the rapid fall off in oil prices, which were coming of a $147 a barrel peak.

In February, just as the Bank of England began printing money, the inflation rate turned around. Since then, the CPI index is up 1.8 percent.

Yes, that is right, in just 3 months, UK prices are up almost 2 percent. Annualise that rate, i.e. multiply by 4, and you begin to see that far from deflating, the price level is actually rising quite rapidly. The four month mild deflation means that this sudden upswing in prices is obscured in the 12 month rate.

In May, prices jumped 0.5 percent. Annualise that rate and we get something like a 6.5 percent inflation rate. So, today's number was really rather bad, and hence the "surprise" felt by many commentators.

Today's number wasn't a "one-off". Over the last four months, the CPI has increased by an average of 0.5 percent. What does that kind of monthly rate mean for short term inflation dynamics. The following chart looks at the 12 month inflation rate assuming that the monthly rate increases by 0.3 percent a month until the middle of next year. This rate is a conservative assumption, since it is a full 0.2 percent lower than the current monthly rate. As the chart implies, if we see this kind of monthly inflation, then we will see a sharp jump in the rate next autumn as the 2008q4 deflation effects fall out of the CPI index.

Today's inflation numbers must have made uncomfortable reading for the MPC. Insofar as there was any deflation, it stopped in January. Now, the monthly inflation rate has picked up sharply and if it maintains its current momentum, then by Christmas the BoE governor will again have to write love letters to the Chancellor, explaining why he has missed the inflation target yet again.

Time to raise those rates, I think.