Written by Oliver Jones, Asset Allocation Strategist, Rathbones
The latest UK inflation figures add to the chance of a 0.5 percentage point interest rate increase by the Bank of England in August, rather than the 0.25 percentage point moves that we’ve seen so far this year.
But we still think that rates will ultimately rise by less than is discounted in markets in the coming quarters, as the economy falters.
Three things have happened in the past week or so that may have increased the likelihood of the Bank of England following other central banks and speeding up the pace of its tightening next month. First, we learned that CPI inflation was stronger than expected in June, rising from 9.1% to a new forty-year high of 9.4%. (And under the hood, services inflation climbed from 4.9% to 5.2%.
That is particularly relevant to the Bank of England, because services inflation is driven mostly by domestic factors which the Bank has some influence over, in contrast to inflation in food, energy and many goods which is driven primarily by global developments largely beyond UK policymakers’ control.) Second, the latest monthly GDP figures released last week showed that the economy held up a little better than expected in May, suggesting that the economy did not do quite as badly in Q2 as the Bank had feared. And third, Governor Bailey explicitly discussed the possibility of a 0.5 percentage point move at his Mansion House speech last week. He has previously sided with the majority of Monetary Policy Committee members voting for 0.25 percentage point increases.
Having said all that, there are still good reasons to doubt that rates will ultimately rise quite as far as is discounted in markets. (Market pricing is consistent with bank rate rising beyond 3% by early next year, from its current level of 1.25%.) Although inflation is likely to rise even further in the near term, as utility bills jump again in October, it should then start to fall, particularly with signs that some of the global factors that pushed it up previously are now fading.
Global energy and food commodity prices have fallen sharply since June, while goods supply chains continue to improve. The latest labour market figures also confirmed that there is no 1970s-style wage-price spiral underway, with wage growth falling back a bit as more workers returned to the labour force. Meanwhile, the growth outlook overall remains poor despite the slightly better-than-expected May GDP numbers.
The economy still probably did little better than flatline last quarter. And the survey data have generally deteriorated recently, while some leading indicators already point to a contraction later this year and the ongoing squeeze on real incomes is far from over. Together, this may help dissuade the Bank from continuing to raise rates further ahead.