UK Inflation Soars

Summary

• May UK inflation beat expectations, with a surprise rise in core and headline readings.
• The beat was widespread, which will add to BoE concerns that it will stabilise at a rate far above target despite the economic slowdown – stagflation!
• Services inflation accelerated too, but the wage-intensive sectors at least showed some stability.

Market Implications

• The market is now pricing a 6% terminal rate by year-end. This seems unlikely, but there is little value in fading the move until the turn has come.

A Broad-Based Problem for the BoE

MPR Forecasts Look Stale

Headline (+8.7% YoY) and core (+7.1% YoY) beat consensus expectations by +0.3ppt.

As a result, the May MPR forecasts are looking very stale (Chart 1). The gap between actual and MPR monthly forecasts widened to 0.4ppt in May, from 0.3ppt in April. While there is likely to be a decent drop in June headline CPI, on the back of energy price reduction, the continued rise in core suggests this gap will continue to widen.

Core Momentum Far to Strong

The +0.7% MoM core reading, while not so extreme as the April level, presented a continued strong beat of typical monthly values (Chart 2). Moreover, since February, core inflation has shown only very small signs of returning towards the 2% target. This rate of return is incompatible with the BoE’s target – more will need to be done to counter it.

Inflation Beats More Widespread

Inflation remained very broad, with 10 out of 12 sectors beating their typical monthly rate in the month (the level seen since around February).

Particularly strong beats came in Clothing, Communications and Recreation. The re-acceleration in restaurant prices is also a concern (Chart 3). This should, if anything, be more worrying to the BoE than the surprise jumps in single sectors seen in April – a sign that the price rises are more evenly spread out.

Services Continue to Accelerate

The April beat in services inflation was predominantly communication services driven (with the annual re-vision of contract rates in April). However, in May, the momentum continued, with a further widening of the actual YoY services inflation over the MPC’s May forecast (Chart 4).

Wage Intensive Services Stabilising

Rising transport services prices proved the largest driver behind the uptick in the YoY inflation rate. There, transport by air rose by 20% MoM. While the sector is notorious for rapid swings in prices, it usually follows strong seasonality. In the last 20 years, only 2013 saw a more rapid May MoM rise (+22%). As such, the effect on YoY inflation was dramatic (+4.7ppt vs April).

There is little positive for the BoE to take from the inflation release. However, the BoE should take some (modest) reassurance that most wage-intensive services sectors are not seeing an acceleration in inflation.

While the YoY rate across wage-intensive service sectors (c.8% on average) remains far too high, at least it is not accelerating. Instead, it is non-wage intensive sectors (supported by one-off jumps; this month: airline travel, last month: comms and non-energy utilities) that are providing the tailwinds. That suggests that the real-wage squeeze continues, household purchasing power continues to diminish, and, consequently, demand will too. It remains to be seen whether this will assist the BoE in shifting its focus away from wage as the main driver.

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.

Photo Credit: depositphotos.com

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