A Big Beat for UK Inflation

Summary

• UK YoY headline inflation is back into single figures (+8.7%), but core (6.8%) and services  inflation (+6.9%) provided a strong offsetting hawkish surprise.
• The details were perhaps less hawkish than the headline – wage-pressure industries are returning towards normal.
• Nevertheless, the breadth of inflation and the trajectory of headline figures strongly support more market hawkishness.
• Looking ahead, the Bank of England (BoE) will have the opportunity to assess May inflation (21 June) as well as May (HMRC) and April (ONS) labour market data (13 June) before its next meeting.
• While positioning for BoE dovishness has been (and continues to be) a painful experience, we would caution that a holistic view on data should be taken, rather than overweighting single outturns.

Market Implication

• A dislocation has emerged between EUR/GBP short-end swap spread and the EUR/GBP spot rate. If relative BoE hawkishness persists in the near-term (our base case), there could be room for GBP strength ahead.

Strong Core Inflation Supports More Tightening

While the labour market is largely developing as we had expected, UK inflation continues to confound both our own and market expectations. April inflation data added further to this mood with beats versus consensus across headline (+8.7% YoY vs 8.2%) and core (+6.8% vs +6.2%), as well as services inflation rising above BoE expectation (+6.9% vs 6.7%; Charts 1 and 2). This suggests inflation is stickier than the BoE had assumed.

Big Repricing Moves

Significant repricing action through April supported the strong move (headline: +1.2% MoM), while the YoY figure was suppressed by energy base effects falling out. We can separate these into telegraphed moves, and surprises (Chart 3):

Telegraphed one-off moves:

• Alcohol and tobacco added 0.16ppt to the headline figure on the back of the significant rise in tax at the Spring Budget (tobacco: +6.9% MoM).
• Communication services added 0.1ppt on the back of annual repricings reflecting last year’s RPI (+8.0% MoM).
• While the fall off of energy base effects drove housing inflation’s contribution (-1.7ppt), the MoM housing metric was supported by significant scheduled rises in water (+8.9% MoM) and sewage (+8.0%) utility fees.

Surprise moves:

• Transport added 0.1ppt to the headline YoY figure on the back of a surprise jump in new (+1.2% MoM) and used car (+2.7% MoM) prices, as well as surprises in transported-related services including maintenance (+2.6% MoM) and other services related to personal transport (+2.6% MoM).
• Actual rents (which sits within housing inflation) saw one of its largest historic MoM rises (+1.4%). Rents tend to be re-priced approximately quarterly (Jan, Apr, Jul, Oct), although the largest moves tend to be in April. However, the scale of rises went far beyond expectations.
• Recreation and culture added 0.2ppt to headline YoY, driven in part by a surprise rise in major recreation durables (+2.9% MoM), recording media (+4.8% MoM) and book prices (+8.2% MoM).

The Breadth of Inflation is Worrying

The breadth of inflation remained strong as the net-effect of the surprise moves in transport and recreation inflation more than offset housing’s decline (the only sector to undershoot typical MoM rates; Chart 4). Meanwhile, the average of the monthly beat stayed high, even when excluding the sectors affected by telegraphed price changes (Chart 5).

Services Inflation Strong, Less Hawkish Details

Service inflation rose to new YoY highs (+6.9%) with the largest MoM jump (+1.6%) in at least 20 years. On the face of it, this seems to be an overwhelmingly hawkish outcome, particularly given the BoE’s focus on the measure. However, the reason for the BoE’s interest is due to the risks that wage rises drive inflation and hence lead to a deleterious spiral. But the detail show that the most wage-intensive services sectors actually saw falling YoY inflation in April (Chart 6). This is a continuation of the disinflationary trend seen there since February (Chart 7). So, if the labour market continues loosening (as we expect) there is reason to expect the disinflation trend to continue, even while one-off repricing effects, such as those seen in non-wage intensive services, fade ahead.

Persistent Hawkish Pricing Could Support GBP

Despite services detail supporting our expectation that the BoE will be able to take comfort from the loosening labour market, to play down the hawkish surprise would be remiss. A strong beat in headline, core and services inflation is unequivocally hawkish. The BoE will need to take note, and, as such, the market pricing for more hiking (pricing is for a 5.5% peak at the time of writing) can probably be sustained in the near term, even if we don’t think they will ultimately get there.

It is, however, still important to see the bigger picture (of a weakening labour market and the distorting effects of tax changes and annual price changes). Tempering the hawkishness at the 22 June meeting will be the fact that we will get another bout of labour market (13 June) and inflation (21 June) data before then. Until then, the market can continue pricing hawkishly.

It is worth noting that a disparity has emerged between the rates and FX markets. As it stands, the 2Y EUR/GBP swap spread has moved markedly lower, but the EUR/GBP spot rate has remained stable (Chart 8). If relative BoE hawkishness persists, there could be room for relative GBP strength ahead. The counter to this could be if EZ inflation next week surprises to the upside, although this is unlikely to fully re-widen the spread.

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.