Bank of England on Alert: UK Inflation Needs Attention
Recent UK inflation data sent mixed signals. Chancellor Hunt highlighted a year-on-year CPI inflation drop to 3.2% in March, down from February's 3.4%. However, this figure exceeded expectations of 3.1%. A closer look revealed concerning trends. Month-on-month CPI, core inflation, and services inflation all showed surprising resilience.
Economists like Sanjay Raja of Deutsche Bank warn of "upside risks" exceeding projections. The Bank of England (BoE) initially anticipated inflation falling below 2% by April due to an energy price cut. But Rob Wood of Pantheon Macroeconomics believes a sub-2% reading might be delayed until May.
Core Inflation: The Key Hurdle
For the BoE to achieve its 2% target, core inflation (excluding volatile food and energy prices) needs to fall further. This, in turn, hinges on taming service inflation, the dominant sector in the UK economy.
Stubborn Services Inflation: A Challenge
Services inflation remained stubbornly high at 6.0% in March, defying expectations of a decline to 5.8%. Economists like George Buckley of Nomura warn that service inflation is "more like there’s a lot more work to do" to bring it in line with the BoE's target.
Upside Pressures Beyond Services
Deutsche Bank identifies additional inflation risks. Logistical issues in the Red Sea could push core goods inflation higher. Food price increases due to potential harvest shortfalls and geopolitical tensions impacting oil and gas prices are also concerns. Deutsche Bank forecasts a temporary dip in headline inflation to around 2% in Q2, followed by a rebound to 2-2.5% in the latter half of 2024.
US Stalling and Impact on UK Rate Cuts
The recent US inflation surge has led to fewer expected rate cuts from the Federal Reserve. This has influenced UK interest rate expectations as well. Markets now anticipate a first UK rate cut only in September, pushing back initial hopes of a June reduction.
BoE's Tightrope Walk: Inflation Tolerance vs. Rate Cuts
Governor Bailey's comments suggest the BoE might tolerate some upside inflation surprises. This raises the possibility of a June rate cut despite lingering inflation concerns. Economists like Ruth Gregory of Capital Economics warn that UK inflation might "follow the trend in the U.S. and soon stall," potentially impacting future rate cut decisions.
A Wait-and-See Approach
The BoE faces a delicate balancing act. While disinflation seems to be pausing, the central bank might still consider a June rate cut if they believe inflation remains manageable. The coming months will be crucial in determining the trajectory of UK inflation and the BoE's monetary policy decisions.
