UK inflation's jump tests BOE's relaxed view on stimulus exit

Consumer prices in Britain climbed 2.5 per cent from a year earlier.
Consumer prices in Britain climbed 2.5 per cent from a year earlier.PHOTO: REUTERS

(BLOOMBERG) - UK inflation unexpectedly accelerated to the highest level in three years in June, driven by widespread price increases that challenge the Bank of England's argument that the surge will be temporary.

Consumer prices climbed 2.5 per cent from a year earlier, exceeding all but two estimates in a Bloomberg survey of 35 economists. Prices rose from May in the vast majority of 12 broad divisions, the Office for National Statistics said Wednesday. The pound advanced.

The jump will strengthen views among investors and a growing minority of economists that the BOE will raise interest rates as soon as next year as the economy recovers from the pandemic. It also shows how inflation is emerging as a test for central banks in major economies, coming a day after US consumer-price growth unexpectedly surged to 5.4 per cent.

"Critically, we do not believe that higher inflation will be fully transitory," Kallum Pickering, a London-based senior economist at Berenberg, who expects the first UK rate hike in August next year, wrote in a report.

While the risk of current price growth becoming more entrenched is still modest, "the warning from history is clear - all periods of high sustained inflation appear temporary at first," he said.

The UK's 10- and 30-year government bonds led a rise in yields across the curve after the data, climbing four basis points. The spread between two- and 30-year debt, which reflects the balance between tightening prospects and inflation expectations, steepened slightly after two days of flattening. The pound gained 0.2 per cent.

The BOE predicts that inflation, which was as low as 0.2 per cent last August, will exceed 3 per cent. But crucially for policy, the central bank has maintained that the pressure would prove temporary.

Governor Andrew Bailey this month dismissed calls for imminent action by saying officials shouldn't overreact to transitory factors affecting prices.

Cathal Kennedy, European economist at RBC, said the Monetary Policy Committee will likely wait to see how the labour market recovers after the government winds down the furlough program in September.

"This is the key, this is we think the key for the outlook," he said in an interview. "For all the talk about anecdotal problems with hiring and shortages in certain sectors, there are still two million in the furlough scheme so it's difficult to get a true handle on what's going on in the labour market at present."

But Robert Wood, an economist at Bank of America Merrill Lynch, said while he still expects inflation to ease back next year, some BOE policy makers may choose not to look through the surge. "The inflation news = more hawkish BOE," he wrote.

Wednesday's release showed prices for food, used cars, clothing and footwear, eating and drinking out, and fuel rose in 2021 but mostly fell in 2020, resulting in the largest upward contributions to the change in the inflation rate. Motor fuel costs rose 20.3 per cent from a year earlier, the most in more than a decade.

The ONS said people were seeking alternatives to public transport and paying more for it, using savings built up during lockdowns. A global shortage in semiconductors held back production of new cars, forcing many to turn to the second-hand market. Prices for used vehicles rose 4.4 per cent between May and June, the strongest increase on record.

These gains were partially offset by a large downward contribution from games, toys and hobbies, where prices fell this year but rose a year ago.

A separate report showed pricing pressures in manufacturing eased slightly in the last month. Manufacturing raw material costs rose 9.1 per cent from a year ago in June, slower than the 10.4 per cent gain the month before. Economists had expected an acceleration. The price of goods leaving factories rose 4.3 per cent from a year ago, less than the gain a month earlier.