The unexpected jump in UK inflation in February, coupled with turmoil in the global banking sector, leaves Bank of England rate setters facing an even tougher decision than usual on Thursday.
The latest data, showing inflation at 10.4 per cent, has reinforced fears that price rises are increasingly being driven by domestic pressures in the services sector, rather than the external shock of high energy prices.
Because these pressures tend to be more persistent, the data has cemented market expectations that the BoE will raise interest rates again.
But in the last fortnight, concerns over the health of the global banking sector have intensified. Although there is no evidence so far of any UK-specific issue, and central banks maintain that financial stability will not get in the way of their inflation-fighting mandates, the tensions in financial markets are likely to make many banks more wary of lending. Other things being equal, this would reduce the need for interest rate increases.
“The surprise inflation rise last month will further complicate the decision facing monetary policy committee members over what to do about interest rates, as they grapple with turmoil in the banking sector,” said James Smith, research director at the Resolution Foundation think-tank.
Some of the surprise rise in February’s inflation data was due to one-off factors such as the weather-related shortages of lettuce and cucumbers that led to empty shelves in UK supermarkets and helped drive up prices of food and non-alcoholic drinks at their fastest pace for 45 years.
But price rises were broad-based, including in sectors such as hospitality, where labour costs play a big role. Annual services inflation, considered a better measure of domestic price pressure, accelerated to 6.6 per cent. In the hospitality sector, it rose to its highest rate on record.
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UK core inflation, which strips out volatile food, energy, alcohol and tobacco prices, rose sharply to 6.2 per cent and it is now 0.7 percentage points higher than that of the US after broadly mirroring it for most of last year.
The continuing high levels of inflation set the UK apart from other major economies. The rate has only marginally slowed from a 41-year peak of 11.1 per cent last October, and the gap between Britain and the US and eurozone has widened.
The acceleration of core and services inflation suggests that “there may be more domestically generated inflation pressure than the Bank has assessed to date”, said Krishna Guha, economist at the investment bank advisory company Evercore.
Kallum Pickering, economist at investment bank Berenberg, said the BoE decision on Thursday “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”.
He noted that Wednesday’s data came after inflation slowed more than expected in January and added that “caution still favours a hold” by the BoE because raising rates before the full impact of global monetary policy tightening has unfolded “risks adding to problems that would eclipse those associated with excess inflation over the medium term”.
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With the UK housing market already reeling from the effects of rising mortgage rates, “the risk is that a hike now could end up pushing inflation below target further down the line”, said Susannah Streeter, head of money and markets at Hargreaves Lansdown, a financial services company
The concerns are that “the banking scare will end up being a disinflationary force by leading to a knock-on effect on lending which could hit the spending of companies and consumers if loans are a bit harder to come by”.
The BoE had been closer to stopping increasing rates than any other major central bank before the recent banking turmoil, but markets now expect a 25 basis point increase on Thursday.
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This would be the 11th consecutive rate increase since November 2021, with the central bank increasing rates from 0.1 per cent by nearly 400 basis points to 4 per cent in an effort to bring inflation down to its 2 per cent target.
UK energy prices, which were the main driver of inflation for most of the past year, are now falling but not by enough to offset the increases in other items. Prices of fuel fell 1.3 per cent between January and February and the annual pace slowed sharply to 5.1 per cent last month, from a peak of 45.8 per cent in July 2022.
Despite the slowdown, UK energy inflation remains much higher than in the US and the eurozone, reflecting the different level of government support and the country’s exposure to the international energy market.
Source: Economy - ft.com
