UK Inflation Figures Stoke Speculation of Rate Hikes

Key Points:

• U.K. consumer price index exceeds forecasts and rises to 2.3% y/y.

• Economists are predicting a 3.0% y/y gain in inflation in near term.

• Bank of England may act to raise rates during their MPC meeting in May.

The latest round of U.K. CPI figures have proved a surprise to the market as rising food and energy prices have pushed the key inflation metric to 2.3% y/y. The result far exceeds the expected 2.1% gain and now places the metric well above the 2.00% range desired by the Bank of England (BoE). The result is the strongest seen in many years and now places increasing the pressure on the BoE to act on interest rates in the medium term.

The immediate response from the release of the inflation data was a sharp rise in the value of the Pound against most of the cross pairs. The Cable rose to a high of 1.2475, breaking through the 100EMA, which suggests that we could see prices creeping back above the key 1.25 handle in the near term. Much of the bullish activity is due to rising speculation that the Bank of England is going to have to raise rates to fight of the growing inflationary pressures in the short run.

However, the one metric that is still lagging behind is wage growth as the latest figures show stagnation in this regard. In fact, despite unemployment falling to its lowest levels in over 30 years, wage gains have slowed and real pay rates have started to slip. Subsequently, inflationary pressures and the requisite cycle of interest rate rises are likely to be unwelcome news to the vast majority of Britons.

Regardless, the reality is that the central bank will view the latest CPI result as a stark warning of the building inflationary pressures within the economy. Although the historically low Pound has certainly had an impact on import prices and purchasing parity it has largely been the global rise in crude oil prices that has led to the recent rises in both food and the CPI. Subsequently, many professional economists are now forecasting inflation to rise to 3% within the U.K. over the coming months. This is something that will be relatively unpalatable to the central bank and could spur action sooner, rather than later.

Ultimately, given the historically low official bank rate, the BoE was always going to have to act to counteract inflation eventually. Unfortunately, the decisive moment has arrived and the central bank is likely taking notice of the rising pressures. The monetary policy committee is not due to meet again until the middle of May but the meeting is set to be a ‘live’ event and there is a very real risk of a 25bps hike to rates, especially if the CPI figures keep rising in the near term.