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U.K. Inflation Surge Prompts Bets for Sharper Rate Increases

·4 min read

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

U.K. inflation surged more than expected to the strongest pace in more than nine years, prompting investors to anticipate a sharper increase in interest rates in 2022.

Consumer prices jumped 3.2% in August from a year ago, the most since March 2012, the Office for National Statistics said on Wednesday. The reading was up from 2% in July and above the highest estimate in a Bloomberg survey.

While much of the increase was due to a comparison with last year’s discounts on restaurant meals, more enduring signs of inflation is fueling expectations that more hawkish Bank of England officials will gain the upper hand in the debate. Policy makers have shifted toward concerns about labor and material shortages leading to more persistent inflation, with a surge in energy costs due to hit in coming months.

The figures “will keep the Bank of England in a hawkish mood, laying the ground for a rate hike in the first half of next year,” said Dean Turner, economist at UBS Global Wealth Management. “In light of this, the prospects for the pound remain bright.”

The pound gained 0.1% against the dollar to $1.3822, and money markets are now betting the BOE will raise the base rate to 0.5% by the end of next year.

The ONS said that much of the inflation increase in August will likely be temporary. The strongest upward pressure came from prices charged by hotels and restaurants. That was heavily skewed by figures from last year when the government’s Eat Out to Help Out program led to large discounts across the sector.

What Bloomberg Economics Says ...

“U.K. inflation picked up sharply in August, making it increasingly likely the Bank of England’s forecast for price gains to hit a peak of 4% at year-end will be borne out. We broadly share the central bank’s view for 2021, but see a faster slowdown in 2022, with inflation ending the year at 2%.”

--Dan Hanson, Bloomberg Economics. Click for the REACT.

But with natural gas and coal prices surging, the cost of electricity is set to rise in the coming months. Oil prices are also climbing, which will boost the cost of gasoline and diesel fuel.

To date, the BOE has been stoking the U.K.’s economic recovery from the pandemic with 150 billion pounds ($208 billion) of asset purchases that are due to finish by the end of this year. Governor Andrew Bailey said this month that the conditions to remove that stimulus and raise interest rates have been met.

The central bank has forecast that inflation will reach 4% by the end of this year, double its target, and then fall back in both 2022 and 2023. The increase in inflation between July and August was the biggest since the current series of data started in 1997. Higher inflation could erode living standards and the value of savings, weakening consumer spending that has been the engine of the economy.

“Savers need to be doing what they can now to ensure the value of their cash keeps pace with, or exceeds, inflation,” said Neil Messenger, director of client and markets at the fund manager Abrdn. “With rock-bottom interest rates, inaction could risk their funds losing value in real terms.”

August’s figures showed more enduring signs that the cost of labor and materials is surging, with higher inflation coming from transport and in manufacturing.

The cost of used cars rose 18% from a year ago in August, and fuels made a big contribution to higher transport costs. Housing and household services also rose sharply, reflecting higher rent costs.

There was further evidence of cost pressures building beyond the consumer level, with the fastest increases since 2011 for producer output and input prices.

The price of raw materials entering factories surged 11% from a year ago in August, more that the 10.4% pace of the previous month, which was revised higher. The price of goods leaving leaving factories and utilities rose 5.9% Both figures were more than economists had anticipated.

The retail price index, used in pay settlements and for the Treasury’s inflation-linked bonds, rose 4.8% from a year ago last month, a full percentage point higher than in July.

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