The Bank of England (BofE) could be set to raise interest rates for the first time in years, according to industry commentators, after the Office for National Statistics revealed that inflation had reached its highest level since 2012.
Consumer Prices Index (CPI) inflation edged higher to 3.0 per cent in September, according to the ONS, reaching a 5.5 year high.
The rise, which was in line with expectations, could be the catalyst for the Bank to begin increasing interest rates for the first time since the onset of the global financial crisis.
Higher inflation was driven by a combination of factors including a rise in food and recreation prices and smaller price gains in clothing, education and hotels.
Much of the UK’s surge in inflation is attributable to the slide in sterling following last year’s EU referendum pushing import costs higher, according to the Office for National Statistics.
Other measures of inflation were more stable with ‘core’ CPI inflation unchanged at 2.7 per cent and retail price index (RPI) measure of inflation – which includes mortgage interest costs – came in a touch below expectations at 3.9 per cent.
Below, FE Trustnet looks at some of the responses to the latest inflation figures with predictions on what it means for the BofE’s interest rate hike cycle and where the figures are likely to go from here.
Much depends on the Brexit negotiations
Inflation has likely peaked, according to Janus Henderson’s head of interest rates Mitul Patel, who said that he expects prices to plateau before lowering over the course of next year as sterling weakness is fully priced-in.
“Wage growth has failed to keep pace with consumer prices, we have experienced a softening in consumption and weaker growth, so as inflation begins to fall we should expect to see consumption stabilise,” he said.
However, much depends on the Brexit negotiations. If talks go well this will likely lead to a strengthening pound and therefore lower inflation, while a breakdown in talks would see sterling depreciate, placing renewed upwards pressure on inflation.
Overall, he said that the Bank remains likely to hike in November following the latest inflation figures.
“Many believe the Bank of England are only sounding hawkish as a result of inflation being temporarily high, as inflation weakens this will lessen the chance of future rate hikes,” said Patel.
“This is an inaccurate reflection of their stance. They believe the diminished level of slack in the UK economy, evidenced by continued declines in the unemployment rate will lead domestically generated inflationary pressures. A hike in November continues to look likely.”
Where will interest rates go from here?
David Page, senior economist at AXA Investment Managers, said the rise in inflation meant a gradual withdrawal of stimulus is likely, forecasting another hike in 2018 and two for 2019.
Not everyone agreed, however. Architas investment manager Nathan Sweeney said with inflation likely to have peaked, any suggestion of a rate hike cycle could be premature.
He said while the latest figures give the Bank of England an extra incentive to raise rates next month, it is likely to give them the leeway to fight the slowdown in growth rather tackle inflation.
“We believe the ability of the Bank of England to enter a rate rising cycle is severely limited by the slowing growth we are seeing in the UK,” Sweeney added.
“In the face of high inflation we are still seeing little wage growth so the pressure is continuing to grow on UK households. This will make it hard for the Bank to make any sustained move to raise rates in the short to medium term.”
Meanwhile, Viktor Nossek, European director of research at ETF provider WisdomTree Investments, said he does not buy into the idea that the BofE are guaranteed to raise rates next month.
“There has been much talk of a rate hike later this year by the Bank of England, but with so many areas of weakness in the economy, and high levels of indebtedness, a rate rise could be a step too far for the Bank of England, at least until there is more clarity on Brexit,” he said.
“The deciding factor could be the pound, but even here the outlook has become more benign, with the currency appreciating substantially off lows and acting as a dampener on inflation.
“While an eye-catching number, the real question is if beyond the peak, inflation will trend lower and be contained enough to sustain consumer spending. Against poor productivity, wages are expected to struggle to even keep up with lower inflation further out.”
And Newton Investment Management fund manager Paul Flood believes that inflation could surprise on the upside, even if it has peaked this month.
“We would expect inflation to remain elevated in the longer term given the accommodative policy and low levels of unemployment, which may put upward pressure on company wage bills, should these costs get passed through into pricing of goods and services,” he explained.
If this is the case, investors will have a hard time trying to beat inflation, with bonds yielding very little and cash even less so.
Performance of index over 10yrs
Source: FE Analytics
Indeed, as the chart above shows, the 10-year UK gilt has seen yields plummet 72.83 per cent over the last decade, currently standing around 1.4 per cent – far below the 3 per cent inflation level.