No rest for the UK economy and Bank of England as CPI comes in higher than expected

The day before the interest rate decision for the Bank of England, this morning the CPI reading for May came in higher than expected at 0.7% taking the YoY figure to 8.7%. This came in line with our view expressed earlier this week that inflation in UK will remain elevated due to some unique circumstances, the main one being Brexit.

What happens tomorrow at the Bank of England meeting?

The expectation is that rates will be raised by 0.25% to 4.75%. However, after this morning’s CPI data some market participants are not ruling out a 0.5% hike.

In our view the Bank of England will stick to the 0.25% hike this month, but it’s likely that their stance will be extremely hawkish and following hikes may be higher – let’s say 0.5%.

Even if they go with 0.5% tomorrow, it may not turn out to be such a big surprise for the market given today’s data, but if Central Banks still stick to the narrative of forward guidance and sticking to expectations, they shouldn’t go for this move.

How does this affect GBP?

The initial reaction after the data was a move towards the upside. Seeing the recent rally in the currency which was backed by higher CPI numbers and Bank of England rate hikes, in our view it’s likely that the recent trend for GBP will continue at least until CPI numbers don’t go below 5%.

GBP/USD chart

The next short-term target is the 1.3 handle. In the long-term, as we are already seeing inflation easing in the US and in the EU, it’s likely that we may see a divergence in Central Bank policies, where the Bank of England will be still in a tightening cycle and the Federal Reserve and ECB are either in pause or easing mode. This would mean continuation to the upside and a tough time for the UK economy and especially for borrowers.