U.K. Inflation’s Jump Above BOE Goal Heats Up Debate on Prices

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U.K. inflation surged unexpectedly past the Bank of England’s target for the first time in almost two years, lifting the pound and adding to speculation about when monetary policy could be tightened.

Consumer prices rose 2.1% from a year earlier, the highest since July 2019, the Office for National Statistics said Wednesday. Economists and the BOE had expected an increase of 1.8%. Core inflation jumped to 2%, the most since August 2018.

U.K. Inflation’s Jump Above BOE Goal Heats Up Debate on Prices

While the central bank expects inflation to breach its 2% target temporarily and fall back at the end of next year, Wednesday’s report is likely to vindicate sterling bulls looking to the BOE to raise its key interest rate in early 2023. It’s also sharpening the focus on a key question for policy makers and investors: how sustainable is the jump in inflation?

“Inflation has risen sharply in recent months and will rise further as the impact of higher commodities prices feed through the supply chain,” said Jack Leslie, senior economist at the Resolution Foundation, a think tank. “But U.K. inflationary pressures are different -- and nowhere as near as large -- as those causing fierce debate in the U.S.”

The pickup reflected higher prices for fuel, restaurant meals, clothing and recreational goods as the economy took a further step out of lockdown.

The pound climbed as much as 0.3% to $1.4123 after the release, affirming the expectation of the likes of Nomura International Plc and Societe Generale SA for the currency to erase all its post-Brexit losses by the end of the year.

Yet the reaction in bond and rates markets was more muted, suggesting traders support the BOE’s view that the inflation gain will be temporary. The yield on 10-year government bonds, as well as bets on the next central bank interest-rate hike, were little changed.

What Bloomberg Economics Says ...

“We don’t expect it to change the central bank’s view that it will ultimately prove temporary. The base effects from energy prices continued to lift price gains. The other key influence came from prices that are likely to be linked to the reopening of the economy.”

-- Dan Hanson, Bloomberg Economics. Click for the REACT.

Separate figures showed that pipeline price pressures continued to build in May. Producer input prices reflecting the cost to industry for fuel and raw materials rose by 10.7% over the past year, their biggest increase in a decade. That’s pushing up the price of goods leaving factory gates at the fastest pace since 2012.

U.K. Inflation’s Jump Above BOE Goal Heats Up Debate on Prices

The ONS said the cost of transport equipment along with metals and non-metallic minerals provided the largest upward contributions to producer price inflation.

“There is a greater level of uncertainty about prices at present, with a possibility that inflation will turn out to be higher if staff shortages persist, triggering stronger wage rises, while cost increases continue to be passed on to consumers,” said Yael Selfin, chief economist at the accounting firm KPMG UK.

BOE Chief Economist Andy Haldane, who departs his post at the end of this month, said last week that pay and costs are already rising and high street inflation “can’t be far behind.”

His colleague Gertjan Vlieghe says policy makers could raise the benchmark rate as early as next year if the labor market recovers smoothly when government job subsidies come to an end in September.

U.K. Inflation’s Jump Above BOE Goal Heats Up Debate on Prices

Market-based inflation expectations remain close to their highest since 2008. The so-called 10-year breakeven rate -- a gauge derived from the difference between conventional gilt yields and those linked to retail-price inflation -- has risen more than 50 basis points this year.

Many economies have seen prices accelerate over recent months, though policy makers continue to play down the risk of a sustained inflation outbreak. In the U.S., headline consumer inflation jumped to 5% in May, the highest in more than a decade. Euro-area inflation is running at 2%, just above the European Central Bank goal.

“We’re still penciling in the first rate hike in early 2023,” James Smith, an economist at ING, wrote in a report. “However, a more rapid economic recovery -- perhaps triggered by greater-than-expected unloading of household savings -- could conceivably bring that forward in 2022.”

©2021 Bloomberg L.P.

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