A surprise rebound in UK inflation led to a sharp swing in the market’s expectations for a Bank of England interest rate rise on Thursday, which had been tempered by worries about the stability of the global banking sector in recent weeks.
But some economists and analysts said the decision was still on a knife-edge, partly as inflation seemed to have been lifted by exceptional factors.
Consumer price inflation unexpectedly rose to 10.4% last month, according to the Office for National Statistics (ONS), confounding the market’s had predicted it would fall below 10% and the Bank’s monetary policy committee had forecast a slight rise to 10.2%
By reversing the declining trend we have seen in recent months, the resurgent CPI figure dealt a “crushing blow” for the Bank’s policymakers, says market analyst Craig Erlam at Oanda.
“Whatever flexibility the Bank of England may have thought it would have tomorrow was wiped out by this morning's inflation data,” he said, adding that for some in the City the conversation had even shifted to whether a rate hike of 25 basis points will be enough.”
Considering both headline CPI and the core number were both expected to decline, Erlam said, “nothing that would justify a pause tomorrow from the MPC, even against the backdrop of financial stability concerns and the knock-on effects of aggressive rate hikes”.
Rob Morgan, chief investment analyst at Charles Stanley (LSE:CAY), agreed that were it not for the hot inflation reading, the interest rate decision “would have been finely balanced” but now the MPC has been given “every reason” to hike again, though he said a 0.25% hike was most likely.
“Inflation is already starting to fall in the US, but it's proving much stickier in the UK, where higher energy prices and the weak pound are keeping inflation figures high,” he said.
“Despite the OBR expecting inflation to drop rapidly to 2.9% by the end of the year, the latest data shows that the threat hasn’t receded. If anything, authorities need to be on even higher alert to ensure that ‘Terminator’ inflation doesn’t keep coming back.”
Not everyone was in agreement, however.
Despite the inflation surprise, Sam Tombs, chief UK economist at Pantheon Macroeconomics, said the outcome of the MPC meeting is still “finely balanced”.
Indeed, he thinks “concerns about financial stability and the recent slowdown in wage growth will ensure that a small majority of members vote to keep Bank Rate at 4.0%”.
He noted that core services CPI inflation – the measure closely tracked by the MPC that excludes transport services, package holidays and education – undershot the MPC’s 6.9% forecast, despite rising to 6.7% from 6.1%.
The headline surprise came from food inflation, which increased to 18.0%, from 16.2%, and from core goods inflation, which rose to 5.7%, from 5.6%.
“The jump in food CPI inflation is linked to shortages of some fruit and vegetables as a result of bad weather in southern Europe and Africa, and so should prove to be temporary,” he said.
He said headline inflation is likely to fall to about 9.6% in March, on the anniversary of the surge in motor fuel prices in the wake of Russia’s invasion of Ukraine, while price rises in the hospitality and tourism sector are likely to be smaller in March than a year ago, when some businesses hiked prices ahead of the increase in VAT, with the contribution of electricity and natural gas prices to the headline rate to fall in April as it will be compared to the huge 54% increase on Ofgem’s price cap in April 2022.
Berenberg economist Kallum Pickering also predicted the MPC would stand pat, but said the CPI upside surprise “skew the risks towards a further hike”.
“The decision will hinge on whether policymakers believe the backward looking inflation surprise is likely to be the start of a trend or whether it is a one-off linked to normal monthly volatility.
“Furthermore, policymakers will need to judge whether a likely period of liquidity hoarding and cautious lending behaviour by banks de facto does the BoE’s job for it – at least for a while.
“As the BoE is likely at or close to the end of its rate hike cycle, as signalled in February by its shift to data-dependant mode, this is probably the most finely balanced decision in living memory.”
Market analyst Fawad Razaqzada at City Index noted that, along with the recent turmoil in the banking sector, the doves among the BoE’s rate-setters will also point to the fact that the impact of past hikes is yet to filter through to the economy.
“They will argue that the cost of hiking too much may outweigh any benefits additional tightening might achieve.”
He said the likes of Silvana Tenreyro and Swati Dhingra will undoubtedly push for no change to rates.
Likewise, he noted that the centrist and more hawkish members of the camp will, as well as the still-high inflation rate, may also argue that price action in Gilts have been comparably more stable than US Treasuries and German Bunds, and a lot less volatile than during the mini-budget debacle last year.
“This is because the market perceives the UK to be better insulated to banking problems seen in Europe and the US.”
All told, Razaqzada plumped for a quarter-point hike at this meeting and then pause to assess the impact of the previous hikes.
“As we saw around the time of the mini-budget crisis last year, the BoE separated its inflation fight from the financial stability risks, by temporarily purchasing bonds while simultaneously hiking interest rates.
“With the BoE joining several other central banks in announcing a coordinated action to enhance the provision of liquidity this weekend, there is no need to announce any bond buying again. So, it can go ahead with a rate hike to try and tame inflationary pressures.”
As many commentators pointed out, it will not just be the rate decision that will impact the currency, stock and bond market sentiment, with the split of the votes to be counted as well as the language the MPC uses in terms of forward guidance.