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UK inflation surprise renews talk of interest rate increase

Posted September 12

— Inflation in Britain spiked up to 2.9 percent in the year to August, official figures showed Tuesday, in a development that has stoked speculation the Bank of England may raise interest rates sooner than expected regardless of how the country's Brexit discussions shape up.

The Office for National Statistics said the increase from the previous month's 2.6 percent rate was largely due to rising prices for clothing and motor fuels. The scale of the increase, which took the consumer price inflation rate to its joint-highest level in more than five years, was unexpected — the consensus in the markets was for a 2.8 percent rate.

The pound jumped to near year-highs against the dollar, a signal that some traders, at least, think that borrowing rates could be heading higher later this year or early next. The pound rose 0.9 percent against the dollar, to $1.3279, and strengthened 0.9 percent against the euro, which was at 0.9011 pounds.

The currency's rebound from its post-Brexit vote lows is potentially negative news for British firms that have big business interests outside the U.K. And the money they make abroad will be worth less when it is brought back to the U.K. That helps explain why the FTSE 100 stock index of leading British firms was a laggard Tuesday. Whereas other stock markets in Europe closed higher, the FTSE 100, which is made up of many international companies like BP and Burberry, fell 0.2 percent.

Inflation is now well above the Bank of England's target of 2 percent. In more normal times, that fact alone would have been enough for the central bank to raise interest rates, which can rein in economic activity, thereby keeping a lid on price increases.

If inflation ends up being more than 1 percentage point above the target, Bank of England Governor Mark Carney will have to write a letter to the government explaining why that's happened and what he and his central bank colleagues are planning to do about it.

However, policymakers are expected to keep the bank's benchmark interest rate at the record low of 0.25 percent at their meeting on Thursday largely because of Britain's uncertain economic outlook. At least two of the nine-member Monetary Policy Committee are expected to vote for higher rates and the minutes of the meeting, also due for publication Thursday, could show a greater willingness to consider higher rates.

"The inflation data builds a stronger case for the Bank of England to look at hiking rates but it is not yet strong enough for the monetary policy committee to act this week," said Neil Wilson, senior market analyst at ETX Capital.

While inflation has risen sharply in the past year largely on the back of the pound's fall since Britain's vote to leave the European Union, the economy has slowed sharply as living standards have been squeezed by higher prices. Also, businesses are increasingly reluctant to invest as they gauge the progress of the Brexit discussions and what Britain's future relationship with the EU will look like. So far, little progress has been made and there are fears that the country will crash out of the EU in March 2019 without a new deal, which could mean tariffs on British goods and other impediments to trade.

Some economists think August's increase may represent the high mark for inflation as the price bump generated by last year's sustained fall in the value of the pound following the Brexit vote begins to fall out of the annual comparison. The lower pound has made imports, especially of food and energy, more expensive.

"Beyond the currency effect there appear to be few underlying inflationary pressures," said Ben Brettell, senior economist at stockbrokers Hargreaves Lansdown. "Labour costs are the main factor in domestic inflation, and growth here remains below long-term averages."

Figures due for publication Wednesday are expected to show that wage increases are not keeping pace with inflation, running at around 2 percent.

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