UK inflation has come in higher than consensus. Headline CPI printed at 8.7%, higher than the 8.4% anticipated, and core CPI was 7.1%, as opposed to the 6.8% expected.
Headline inflation should decline over the next few months as base effects kick in. However, core inflation is likely to prove more resilient.
This will see at least a 25bps hike tomorrow by the Bank of England, with 50bps a slight possibility. However, markets are now pricing in a 6% peak for the official bank rate, which is a fair way away from the current 4.50%.
A 6% Bank rate will prove to be very restrictive. It would be more difficult to borrow money or apply for mortgages. Moreover, mortgages typically have a fixed period for two or five years. I.e., the rate hikes are taking time to pass through the transmission mechanism. This means that previous hikes are still to be felt throughout the economy. Even if rates do not hit 6%, keeping them high for an extended period could still have a significant negative effect on the economy.
There is little doubt that core inflation's trajectory is heading in the wrong direction (blue arrow). Of concern is its rate of change (ROC), which has accelerated upwards (red arrow). The BoE is especially focused on services inflation. In this regard, the fall in gas prices may result in services disinflation. Nevertheless, ideally the ROC needs to drop to the deceleration side of zero.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.