Jun 21, 2023

UK Inflation Overshoots Again, Heaping Pressure on BOE

Tom Rees and Philip Aldrick, Bloomberg News

UK consumer prices rose 8.7% from a year ago in May. , Bloomberg

(Bloomberg) -- UK inflation remained higher than expected for a fourth month, leading to a flurry of bets that the Bank of England will interest rates to 6% and drive up the cost of mortgages higher.

The Consumer Prices Index rose 8.7% in May, the same as the month before, the Office for National Statistics said Wednesday. Core inflation, excluding food and energy, accelerated unexpectedly to a 31-year high of 7.1%. Economists had expected a headline reading of 8.4% and no change for core.

The figures raise the specter of the Bank of England opting for a bigger rate increase on Thursday, adding to the quickest monetary tightening in four decades. A separate report showed government debt now exceeds the size of the UK economy for the first time since 1961, imperiling Prime Minister Rishi Sunak’s promise to restore health to the public finances and cut inflation.

“It is looking increasingly likely that it will require a recession to finally get the inflation genie back into the bottle,” said Stuart Cole, chief macro economist at Equiti Capital in London.

Traders piled into wagers for more BOE interest-rate hikes. Money market pricing fully priced its key rate hitting 6% by December. Investors see around a 50% chance officials will opt for a larger half-point hike Thursday.

Suank’s government summoned lenders to talk about how to support homeowners struggling with mortgages, with more than 1 million due to refinance this year at significantly higher rates. That along with a cost-of-living squeeze is pushing more families to the brink a little more than a year away from the deadline for the next election. The BOE’s decision Thursday is likely to crystalize those concerns and push the issue higher on the political agenda.

“There is a strong argument for a 50-basis point hike at tomorrow’s Bank of England’s meeting,” said Charles White Thomson, CEO at Saxo UK. “The bank needs to take the initiative quickly. The risk for further policy failure is real, and the stakes are getting increasingly high.”

What Bloomberg Economics Says ...

“May’s surprise rise in core inflation will cast a large shadow over the Bank of England’s June meeting. While we still think a 50 basis-point hike is unlikely, there’s now a good chance of a minority vote for a bigger move. The central bank’s messaging is also likely to be more hawkish, though we think any tweaks are likely to be fairly measured — rate expectations have surged since the BOE last met, but it’s not clear they need another nudge higher.”

—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.

The BOE has raised rates at 12 consecutive meetings from 0.1% to 4.5% and is expected by economists to lift them by at least a quarter point to 4.75% on Thursday. Mortgage rates have now surpassed the 6% level that’s well into the territory the BOE has described as problematic, and further rate rises are likely.

“It is possible that the Bank will raise rates by 50 basis points tomorrow and will need to hike rates above 5.25% to get on top of core inflation,” said Paul Dales, chief UK economist at Capital Economics.

Britain remains an outlier among major economies with prices rising more than four times faster than the central bank’s 2% target. BOE Governor Andrew Bailey is concerned about signs inflation is remaining more persistent despite the quickest round of rate hikes in four decades.

Used car prices along with airline tickets and the cost of recreation and culture drove the increase, suggesting that price pressures have moved beyond food and energy into the rest of the economy.

“The cost of airfares rose by more than a year ago and is at a higher level than usual for May,” said Grant Fitzner, ONS chief economist. “Live music events and computer games also contributed to inflation remaining high. These were offset by a fall in the cost of petrol. Food price inflation remains high, but the rate has eased slightly.”

“High headline inflation piles on the pressure for more rate hikes,” says Yael Selfin, chief economist at KPMG UK. “Today’s data will likely leave the Bank of England with no choice but to opt for another increase in the base rate tomorrow.”

Two price measures being closely watched by the BOE for signs of domestically generated inflation picked up again. Core inflation - which excludes volatile food and energy prices — unexpectedly accelerated to a fresh 30-year high of 7.1% while services prices increased by 7.4%, up sharply from a rise of 6.9% in April.

Deficit Soars

In a separate report, the ONS said government debt climbed above 100% of GDP for the first time since 1961 after the government borrowed a greater-than-forecast £20 billion ($25.6 billion) in May.

The deficit, second highest for the month since modern records began in 1993, was up from 9.4 billion a year earlier. The increase was driven by cost of living payments including energy subsidies and higher staff costs.

The figures make it hard for Sunak to deliver the big tax cuts many Conservatives say are needed if the party if to avoid a defeat in a general election expected to be held next year.

High inflation and rising interest rates are weighing heavily on the public finances as well. Debt servicing costs for May alone were £7.7 billion, £700 million more than the Office for Budget Responsibility forecast.

Public sector strikes as workers demand pay keep up with prices have delivered bigger pay deals than the government had planned.

As a result, staff costs for may were £3.4 billion higher than last year – largely due to the NHS pay deal. Support for household energy bills cost £3.6 billion in May, £1.4 billion more than last year. Inflation also added £2.9 billion to welfare spending, as benefits were uprated in line with inflation in April.

Chancellor of the Exchequer Jeremy Hunt said the priority is to fight inflation.

“We will not hesitate in our resolve to support the Bank of England as it seeks to squeeze inflation out of our economy, while also providing targeted support with the cost of living,” Hunt said in a statement. “We know how much high inflation hurts families and businesses across the country, and our plan to halve the rate this year is the best way we can keep costs and interest rates down.”

Inflation is falling more slowly in the UK partly because falling commodity prices are passed on to regulated domestic energy bills with a lag. Also, Britain had more than 500,000 people drop out of the jobs market during the pandemic, forcing companies to bid up wages to secure the staff they need.

Bailey said last week that inflation will come down but that it is taking a “a lot longer than expected.” He warned of a “very tight” jobs market, highlighting that many firms are hoarding workers given the difficulties to recruit.

Slower inflation is crucial to the political fortunes of Sunak, who made halving price growth by the end of the year one of his five key pledges.