Proactive Investors - Stubborn inflation is proving a thorn in the side of the Bank of England with markets now pricing in interest rates above 5% by the end of the year.
Consumer price inflation rose 8.7% in April, down from 10.1% in March, but well above City expectations for growth of 8.2% and those of many members of the Bank's monetary policy committee (MPC).
Worse, core inflation, which strips out energy, food, alcohol and tobacco, actually rose by 6.8% in April, from 6.2% in March, the highest rate since March 1992.
Susannah Streeter, head of money and markets at Hargreaves Lansdown (LON:HRGV) said: "Inflation has soared up like an eagle and taken a ferocious bite out of our standard of living, but it’s coming down at a snail’s pace and leaving a sticky trail of prices in its wake.”
Samuel Tombs at Pantheon Macroeconomics thinks a further increase in the base rate to 4.75% at the MPC meeting in June from 4.50% “now is firmly on the table.”
He thinks the marginal drop in food inflation to 19% from 19.1% will worry the committee given the “sensitivity of households’ inflation expectations to food price changes.”
ING’s James Smith agreed; he feels food prices are now the BoE's “biggest headache” and the stickiness of inflation “undoubtedly” puts pressure on for another hike next month.
Kallum Pickering at Berenberg expressed concern at the jump in the core rate of CPI, which he thinks will concern policymakers more than the slower-than-expected fall in the headline rate.
Nick Rees, forex analyst at Monex, said the rise in CPI appears to have been fuelled by stronger-than-expected price growth in parts of the services sector, notably, recreation and culture, but also communication and transport.
“The uptick in services inflation suggests that at least some firms in the sector are passing on these increased wage costs, which will set alarm bells ringing amongst policymakers concerned with embedded inflationary pressure and the potential for a wage price spiral”, he warned.
Easing factory prices to help with food inflation?
One brighter note was highlighted by Berenberg’s Pickering. He pointed out that in contrast to the big upside surprise to consumer prices, producer price pressures eased by more than expected in April.
“If history is any guide,” he said, “the big drop in producer price pressures should lead consumer prices for goods lower within three to six months.”
However, ING's Smith explained that the UK is now in an unusual situation where food inflation has diverged noticeably from the relevant producer output price measure.
Producer prices have undoubtedly peaked on a year-on-year basis, he said.
If the recent increases in output prices continue for the rest of the year it would bring food inflation back to the 6% area or below by Christmas.
“In practice, we doubt the deceleration will be that aggressive, but there are nevertheless good reasons to think that food will be contributing less to overall inflation by the end of the year,” Smith thinks.
When will interest rates peak?
There was broad agreement that rates would rise further but there were question marks as to whether they would peak as high as markets are now pricing in.
Berenberg’s Pickering expects a 25 basis point rate rise to 4.75% at the June meeting with a 30% probability of further hike in August.
“Looking further out, we now expect just one cut in Q4, lifting the end-2023 rate to 4.5% from 4% previously. We keep our end-2024 call for a 3% rate unchanged – we now expect six 25bp cuts next year instead of four.”
He noted financial markets now expect the BoE to hike by a full 25bp in June, August and September, with a further 10bp priced in for November to a peak bank rate of 5.35%.
However, he feels the move is “too big.”
ING’s James Smith agreed. “If nothing else, market pricing, which on the back of this data is now pricing more than three additional hikes from the BoE, looks too aggressive.”
Rees at Monex thinks there remains a significant chance that the upside beat seen today represents falls in inflation that have been “postponed rather than absent entirely.”
“Energy and food prices should continue to fall mechanically over coming months, as the decline in commodities prices continue to filter through to consumer inflation,” he said.