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Core inflation gives an unwelcome headache to the Bank of England

There was some good news and bad news on UK inflation today, as headline CPI fell below 10% for the first time since August last year to 8.7%, and the lowest level since March last year. It was also encouraging to see PPI input and output prices slow more than expected in April on an annual basis, to 3.9% and 5.4% respectively.

Unfortunately, this is where the good news ended as while we saw inflation fall back in April it wasn’t as deep a fall as expected with many hoping that we’d see headline inflation slow to 8.2%. The month-on-month figure was much hotter than expected at 1.2% and core prices surged from 6.2% to 6.8%, and the highest level since 1990.

This will be particularly concerning for the Bank of England where Governor Andrew Bailey spent most of yesterday delivering a litany of excuses as to why the monetary policy committee couldn’t operate with the benefit of hindsight.

The areas where inflation is still looking hot is around grocery prices which saw an annual rise of 19.1%, only modestly lower than the 19.2% in March, while services inflation in hotels and restaurants slowed from 11.3% to 10.2%. We already know from the Kantar grocery numbers earlier this week that food inflation is slowing, in May it came in at 17.2%, but the process is looking increasingly glacial.

With wage growth continuing to look solid currently averaging 6.7%, but in some areas of the economy, trending much higher its likely to see core prices remain elevated for quite some time, even as the headline numbers continue to slow over the summer. Nonetheless today’s inflation numbers have increased the possibility that the Bank of England will have to hike rates again at the June meeting from their current 4.5%, which comes just after the May inflation numbers are released on 21 June.

Markets are already pricing that rates could peak at 5.5%, 100bps above where the base rate is now. That’s not good news for mortgage rates, although there’s an awful lot of water that can flow under the bridge between now and the June meeting, and May CPI could surprise to the downside. Andrew Bailey and his cohorts will certainly be hoping so as their stewardship of UK monetary policy increasingly comes under fire. 

For now, the central bank is in the invidious position of having no good options. Do nothing and inflation will take longer to work its way out of the system, squeezing consumers further, raise by 25bps to at least show they are trying to do something, or be more aggressive and push the economy into recession. 

The pound is slightly firmer after today’s inflation numbers but gilt markets are already pricing in higher rates for longer with the UK 5 year gilt back at 4%, while the 10-year gilt yield is back at 4.15%, both back at their highest levels since last October.

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