The pound jumped on Wednesday morning after UK inflation blew past forecasts and put pressure on the Bank of England to act sooner on interest rates.
Data published by the Office for National Statistics on Wednesday showed inflation hit 2.1% in May, blowing past forecasts of 1.8% and topping the Bank of England’s 2% target. The measure of rising prices leapt from 1.3% in April.
Bank of England governor Andrew Bailey will now be forced to write a letter to the chancellor explaining why price rises have breached the central bank’s target.
Red hot inflation also puts pressure on the Bank of England to raise the UK’s rock-bottom interest rate to curb price rises before they run out of control.
“For CPI to smash through the Bank of England’s 2% target isn’t just symbolic,” said Sam Fuller, director of Financial Markets Online. “It opens the possibility of the Bank stepping in to put a lid on inflation – and the way the Bank tends to do that is by hiking interest rates, which could quickly dampen the consumer spending on which the recovery depends.
“Some of the surge in inflation can be explained away by temporary supply issues and the one-off effect of May’s big easing of lockdown restrictions. But nevertheless the Bank of England will be on red alert. If inflation continues to rise, the likelihood of it weighing in will increase steadily.”
Sterling rose sharply in the wake of the data. By shortly after 8am, the pound was up 0.3% against the euro to €1.1646 (GBPEUR=X) and up 0.3% against the dollar to $1.4118 (GBPUSD=X).
“Gradual inflation is beneficial but having too much of a good thing too soon is not,” said Rachel Winter, associate investment director at Killik & Co. “If inflation becomes unmanageable, the Bank of England may be forced to raise interest rates much sooner than anticipated.”
Bailey has said the Bank expects inflation to breach target before dropping back later this year. Like other central bankers around the world, he thinks transitory factors — such as a recovery in oil prices — and a comparison to last year when prices were cratering exaggerates inflation. These temporary factors should start to fade later in the year, he argues.
However, outgoing Bank of England chief economist Andy Haldane has been sounding the alarm on inflation in recent months, warning that reopening the economy threatened to spark runaway price rises that could run out of control.
“It’s pretty clear reading the details that there is a reopening effect, with the likes of restaurant and hotel prices increasing on the month,” James Smith, a developed market economist at ING, wrote in response to Wednesday’s inflation data.
Even still, economists like Smith think Bailey and his colleagues will resist pressure to act given the risk of derailing the UK’s economic recovery. Smith said ING doesn’t expect the Bank of England to raise rates until early 2023.
Hannah Audino, economist at PwC, said: “We expect the Bank of England to see through the recent rise in inflation and continue to prioritise supporting the recovery with low interest rates, over reducing inflation.”
The debate over inflation in the UK forms part of a global conversation that has gripped the market in recent months. Central banks around the world have sought to calm investor nerves about soaring price rises by arguing that inflation is temporary and transitory.
A Bank of America survey of global fund managers, published on Tuesday, found that 72% agree that inflation is likely to be temporary.
– Reuters