UK Inflation And What The BoE Will Do About It
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At the moment, there is a 65% chance that the BoE will raise rates by another quarter of a point at its next meeting. What could substantially change those expectations, and cable with them, is CPI coming in different from current expectations. And there are quite a few underlying issues that could push inflation away from current forecasts.
But, that’s not the only issue that could move the pound substantially. Other central banks are in the process of winding down their hiking programs after their inflation has started to come down. The UK is now in an entirely different position by itself, with over a year of consecutive hikes and inflation still in the double digits.
What’s expected
Inflation is expected to have stayed in the double digits for another month but at 10.2% compared to the 10.4% reported previously. Yes, that’s lower than the peak at over 11%, but it’s still five times the BoE’s target and has remained persistently stubborn.
The core rate is doing substantially better and is expected to come in at 6.0%, down from 6.2% in the previous reading. That’s in line with the core rates of other major currencies, such as the dollar and the Euro. Since the BoE cares about the core rate primarily, this implies that the Bank of England could act along similar lines to the other central banks when it comes to monetary policy. That might end up taking markets by surprise as they fret over the high headline CPI rate.
The core issue
The headline rate includes volatile elements such as energy and food. While energy prices have remained relatively high, they are on the way down and are expected to be lower as gas and electricity prices come in line with where they were before the war in Ukraine. The issue is food, particularly fresh foods. The grocery basket remains the largest contributor to inflation in the UK.
The issue for the BoE here is that the price of grocery items must do primarily with problems that are not related to monetary policy. Less rain in Spain has led to less production of cucumbers and tomatoes, specifically, which have gone up substantially in price. Hiking interest rates won’t make it rain more in southern Europe. As a net importer of food products, the UK is dependent on trade to maintain food prices lower. And it just wouldn’t be polite for Governor Bailey to blame 10 Downing Street for higher food prices.
The market reaction
Gilts price in the cost of inflation as part of the expected return on investment. Higher headline inflation puts upward pressure on yields, which in turn slows money circulation. With the UK narrowly escaping a recession last year, high inflation can translate into slower or negative growth.
What this means is that if the headline CPI number were above expectations, the reaction in the pound to the upside could be muted or fade rather quickly. Inflation below expectations, on the other hand, would also likely weigh on the pound.
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