Markets get the “hump” as UK inflation ticks higher

Having just cut rates by 25bps at its most recent meeting the last thing the Bank of England will have wanted to see is headline inflation pushing back up to 3%, and a 10-month high earlier this morning.

Unfortunately, that is precisely the situation it finds itself in, and makes it much more difficult to deliver another rate cut in the short term, although markets still appear to be pricing another cut in May, as well as August.

While August is certainly plausible, May could be too soon given that inflation pressures are unlikely to have subsided by then.

This is because the April inflation numbers will see a whole host of price rises in the cost of living, from increases in rail fares, council tax, as well as energy, water and broadband bills, which are set to come into effect, and which are all set to rise above the current headline inflation rate.

Today’s inflation numbers also call into question the reasoning behind the recent shift in position of external MPC member Catherine Mann in calling for a much larger cut of 50bps which she justified on the grounds of concerns that financial conditions might need to be a little looser given the current economic climate.

With wages growth also showing little sign of slowing, coming in at 5.9% for the 3-months to December, the monetary policy committee is on the horns of a dilemma, looking at a stagnant economy and inflation that appears to be showing little signs of slowing.

There was little in the way of comfort for central bank policymakers either, with core CPI rising to 3.7% and services inflation rising to 5%, after falling to 4.4% at the end of last year.

That said the central bank said it remains confident that inflation will fall back to target over time, with Bank of England governor Andrew Bailey keen to stress that the central bank is expecting a “hump” in inflation, and that it would be short in duration.

Looks like central bankers have discovered a new word for “transitory”, with today’s hump in inflation prompting equity markets to slide back, as rate cut expectations get pared back, and yields pop higher.

Sadly, for the Bank of England their forecasting record isn’t exactly stellar in this regard over the last few years, so markets should be wary of setting too much store by them whether inflation be hump like or transitory, or whatever other adjective you want to assign to it.

This optimism about a “hump” also overshadows the fact that last year’s October budget measures on business haven’t as yet filtered into the headline numbers on wages, as well as the headline inflation numbers.  

Even more concerning for those battling cost of living pressures is that food price inflation rose 3.3% in January, up from 2% in December, and at odds with some economists who had expected to see a fall in prices.

Education also saw a sharp rise in headline inflation of 7.5% as private schools increased their fees in response to the government's tax changes on the sector.

Businesses will also have to contend with the higher costs of employing existing staff with the increase in the minimum wage, and the increase in national insurance costs, which will likely lead to higher prices.

In the longer term these changes could also lead to job losses, although so far there is little evidence of that in the headline unemployment numbers that could change if the economy doesn’t pick up.

In the wake of the pandemic there was a reluctance on the part of employers to let go of people lest they might need to rehire if business subsequently picked up.

There may not be such a reluctance on this occasion to let people go given that businesses in hospitality and retail are already under pressure, as a result of the slowdown in the economy at the end of last year.

We’ve already seen unemployment rise from levels of 4% in the summer of last year to current levels of 4.4% and the highest level in 3 years. Unless we see a pickup in economic activity in the next few months this figure could rise further as businesses cut costs and raise prices to maintain profitability, and margins.

We hear a lot from government spokespeople that a lot of the price pressures predate the current government, however the decisions made since the new government came into power last summer are only serving to make the UK’s current problems worse.

This is particularly notable around energy policy, which is the life blood of any business and economy, and where the UK pays the highest prices in Europe.

By the government's own admission these energy price pressures aren’t expected to abate in the short term, which means we can only expect to see more persistent inflation in the months ahead, unless the government changes course.