The latest monthly CPI update for May from the UK was released yesterday and came in at 2.9%, up 2.7% from April. Inflation is now at its highest level in 4 years and with the Tories acknowledging that 7 years of austerity played a key role in their poor performance in the election, it seems that prices will receive a supply side boost from the government as austerity is rolled back. This can only add further upside pressure on prices and on the MPC to hike rates should prices continue to diverge from their 2% target rate.
The MPC has a policy meeting on Thursday and no change is expected at this juncture. However, Kristin Forbes, whose 3 year term as a member of the interest rate policy setting committee comes to an end in June, did vote for a rate hike last time out. It remains to be seen if other members see fit to follow her lead. Sterling responded positively to the inflation data, trading ¾ of a cent higher against the euro and the dollar over the course of the day. Markets only have an initial rate hike to occur in H2, 2019 so there is plenty of latitude for sterling currency and interest rate markets to rally on a re-calibration of interest rate expectations.
In its May Inflation Report, the Bank of England stated that projections depend importantly on three main judgements: that the lower level of sterling continues to boost consumer prices broadly as projected, and without adverse consequences for inflation expectations further ahead; that regular pay growth remains modest in the near term but picks up significantly over the forecast period; and that more subdued household spending growth is largely balanced by a pickup in other components of demand.
If the new government loosens the purse strings; deciding to boost pay for public sector workers and increases the minimum wage, these actions could result in the MPC reassessing how much inflation it is prepared to tolerate. The MPC may also begin to factor in that the minority government will increase the probability of a soft Brexit or push the timing of a Brexit out past the MPC’s forecast horizon; variables that may see the MPC look to move the base rate on a path above which is currently forecast by markets. We get an update on employment data and wage growth this morning. Real wages are expected to remain negative and the market and the MPC will need to see weekly earnings pick up before we see a bias within the MPC to hike.