What is the current inflation rate in the United Kingdom? Choose from several possible answers!
The Bank of England is widely expected to raise interest rates in September – the only issue is whether it acts again by 0.5% or decides 0.75% might be required. Certainly the more hawkish elements on the MPC will be concerned about this week’s inflation report and the indications from the employment report about future inflationary pressures.
Headline inflation on the CPI measure was 10.1% in the year to July, double digit for the first time in 30 years and the worst amongst the largest G7 economies. However, two other inflation measures also matter. The Retail Price Index reached 12.3%, significant for a range of gilt payments and pension arrangements. Core inflation, which excludes energy, food, alcohol and tobacco, reached a worryingly high rate of 6.2% in the year to July 2022.
The MPC is well aware that the majority of the factors causing the inflation surge are global in nature, especially gas prices but also a range of foodstuffs, up more than 12% from a year ago in the CPI basket. However, domestic inflation pressures should not be ignored. This is where the latest employment report needs to be considered carefully. UK wages are growing by 5.1% year on year. While this is a little lower than see in May, there are few signs that demand for labour is easing quickly. The UK unemployment rate was steady at 3.8% in the three months to June; a year earlier, the rate was 4.7%. The MPC will note that service sector inflation has hit a 30-year high, rising by 5.7% on the year.
Where next? In its latest forecast the Bank of England expects headline CPI to reach 13% in coming months. In truth, however, the outcome of the Ukraine-Russia war or the impact of potential climate change shocks mean the range of outcomes is still rather wide. Although oil and many other commodity prices have fallen sharply this week, on the back of an array of weaker than expected Chinese economic data, gas prices remain too high for comfort. Hence, a growing number of market participants consider that UK interest rates will need to reach above 3% and stay there for a lengthy period.
Similarly, the minutes of the latest Federal Reserve meeting showed that officials discussed the need to keep interest rates at levels that restrict the economy “for some time” in a bid to contain the highest inflation in 40 years. The minutes also reported that the consensus amongst policymakers was that the current 2.25%-2.5% target of funds rate is around the neutral level, meaning that further rate hikes are necessary to move to the restrictive territory.Supporting such a view, Fed President James Bullard indicated that he is leaning towards another 0.75% hike in September. His colleague Mary Daly highlighted the need to push interest rates to the restrictive territory to bring inflation down to its 2% target.
Europe is seeing similar inflation pressures. The EU CPI figure was confirmed at 8.9% in the year to July – and would have been higher if it was not for substantial fiscal support from the French and German governments to restrain household energy costs. Higher than expected inflation and confirmation that central banks feel that they need to act helps explain why the UK and European 10 Year government bond yields showed a sharp jump over the past week. The UK yield curve has also inverted, following the pattern seen for some weeks in the USA, and the European curve is flatter, all suggesting weaker economic activity ahead. More substantial signs that headline and especially core inflation remain on an upward path can only encourage more central bankers to talk and to act tough.
Bond yields at the time of writing this week
% 2 year 5 year 10 year
USA 3.22 3.03 2.88
UK 2.44 2.21 2.34
Germany 0.74 0.93 1.11
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making