UK Core Inflation Hits Highest Level Since 1992 as Markets Upwardly Revise BoE Rate Expectations

This morning, UK inflation surpassed expectations as markets continue to weigh on the Bank of England’s monetary policy moving forward.

Core inflation rose 30bps to 7.1% on an annualised basis as the index hit its highest level since 1992. Given that this figure strips away the volatile indexes of food and energy, economists are weighing on how this may be indicative of the prevalence of ‘sticky’ inflation – and thus cause a further headache for Threadneedle Street, Westminster, and the UK’s 22 million households.

When looking at headline inflation, the index remained unchanged from last month’s figure as it came in 30bps above the general market consensus. While the 8.7% print marks a slowdown from the recent peak of 11.1% seen in October, it continues to remain well above the BoE’s 2% target rate, raising bets of interest rates being tighter for longer.

As we looked at earlier this week, markets have been upwardly revising their rate hike expectations for the BoE following a flurry of hotter-than-expected data around the UK labour market which showed unemployment falling, wages rising and more people in work than ever before. With markets assessing the inflationary impact of the data, the implied terminal rate expectation for the BoE rose to around 5.7% by H1 2024.

However, given today’s hotter-than-expected print, markets have further upwardly revised their terminal rate expectations with money markets now pricing in a terminal rate of 6% in Q1 2024 and remaining close to this level into Q2. If these expectations are actualised, a benchmark rate of 6% would represent the highest rate since February 2000. This comes as markets have fully priced in a 25bps hike tomorrow to bring the base rate from 4.5% to 4.75% with around a 30% chance of a 50bps hike. Money markets are also pricing in a cumulative 75bps of hikes between now and August, which would see the base rate rise to 5.25% within the next two months.

As markets weigh on a continuation of the BoE’s tightening cycle, yesterday saw the average rate for a two-year fixed mortgage deal increasing to 6.07%, as it reached fresh 2008 highs.

This comes as yields on 2-year gilts have risen 11bps over the last 24hours, breaching 5%. Meanwhile yields on the UK 10-year have risen 10bps to around 4.43%.

As such, all eyes are on Threadneedle Street tomorrow at 12-noon where the Bank of England will make their latest interest rate announcement and provide monetary guidance.

Public Sector Debt Surpasses 100% of GDP

Compounding problems for the UK, Data out this morning also shows that the UK budget deficit is continuing to remain high as government spending soars. Public sector net borrowing over May came in at £19.22bn, well surpassing expectations of £14.9bn. This comes as public sector debt reached more than 100% of GDP, marking the first time this has happened since 1961. With this figure rising, government spending will likely have to increase to meet increasing debt interest payments and inflation linked tax credits, further compounding the Treasury’s headache.

Food Inflation Dips

With household budgets continuing to be stretched, economists were able to see some positive trends as food inflation fell 70bps from April’s 19.1% figure. CEO of the British Retail Consortium, Helen Dickinson stated that “it is a really positive sign that food inflation has fallen for the second consecutive month, the first time this has happened since the Ukraine war began. While some prices continue to rise, we are now seeing regular news reports of falling prices on many essential products, such as loo rolls and vegetable oil”. While the rate of food inflation shows signs of slowing down, it nonetheless remains historically high at 18.4% – just down from March’s figure of 19.2% which represented the highest level in 45 years.