United Kingdom inflation surprise kicks sterling higher

Monetary Policy Committee (MPC) members Michael Saunders and Ian McCafferty both broke ranks again to vote for a jump in interest rates to 0.5% in an attempt to combat the aforementioned rise in United Kingdom inflation – especially with it recently beating expectations by jumping to 2.9%, up from the previous period’s 2.6%.

The weak economy is now winning out, but the bank’s words on Thursday are the clearest indication yet that it may raise rates in the coming months to help keep inflation down, and that markets are underpricing the chance for a hike in the near future. We expect the Bank of England to keep its policy settings unchanged this week while seeking to support the currency with more hawkish rhetoric.The continued softening in the economy, however, puts a cap on the ability of the BoE to induce a repricing of expectations in the front end of the yield curve, in our view. Could we see a series of slow and gradual rate hikes a la Federal Reserve, before the BOE concentrates on its balance reduction programme?

Mark Nash, head of global bonds at Old Mutual Global Investors, says the MPC’s surprisingly hawkish tone shows the market got it wrong, “failing to price in any hikes meaningfully in the near term”.

The Old Lady of Threadneedle Street will nearly certainly leave both interest rates and its bond-buying programmes unchanged when the announcement comes at 12.00 p.m. BST (7.00 a.m. ET). “The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment”.

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Sterling fell to a nine-month low against a range of currencies last month.

U.K. August inflation data came in perkier than expected, with the headline consumer price index (CPI) figure spiking to 2.9% y/y, up from 2.6% y/y in July and matching the cycle high that was seen in May. But the reality is that they aren’t going to raise rates particularly soon’.

Inflation has now returned to a four-year high of 2.9 per cent, while core-inflation has risen to a six-year high of 2.7 per cent. But in recent months they have become increasingly concerned that subdued investment and feeble productivity growth is hurting the economy’s capacity to produce goods and services without causing inflation.

The Office for National Statistics said Wednesday that average weekly earnings growth in Britain was stuck at 2.1 percent in the three months to July when compared to the same period the previous year, with or without bonuses taken into account. Two statements stand out, the first that the market is under-pricing the risk of a rate rise. He said the financial system was now “safer, simpler and fairer”.

The BoE’s step toward tighter monetary policy comes as the Federal Reserve is gently increasing short-term interest rates in the United States and the European Central Bank ponders when to round off its multi-trillion euro asset purchase programme amid a buoyant eurozone economy.

“Such warnings have failed to gain meaningful traction, as persistently weak economic data has repeatedly undermined the MPC’s message”, he said.