UK inflation accelerated unexpectedly for the first time in four months, spurring a rally in the pound and a selloff in government bonds as traders firmed up bets on further rate hikes from the Bank of England.
(Bloomberg) — UK inflation accelerated unexpectedly for the first time in four months, spurring a rally in the pound and a selloff in government bonds as traders firmed up bets on further rate hikes from the Bank of England.
Consumer prices advanced to 10.4% in February, surpassing all estimates in a Bloomberg survey. The yield on two-year gilts rose as much as 20 basis points and the pound jumped to the highest level in over a month, while money markets fully priced in a quarter-point hike Thursday.
Prior to the data, traders were doubtful that the BOE would hike at all, in light of tightening financial conditions and fears over the health of the global banking system. The shock inflation acceleration will likely intensify the debate at the monetary authority, where divides have emerged on the Monetary Policy Committee over how much further to raise rates given the headwinds to growth.
“This cements the call for another 25-basis-point hike at this week’s meeting,” said Antoine Bouvet, a strategist at ING Groep NV. “This is an ugly report, and especially disappointing after the false hope given by the drop in core inflation in the January report.”
The Federal Reserve’s decision later Wednesday will also set the tone for the BOE. While most economists expect a quarter-point interest-rate hike, some say policymakers should pause to shore up financial stability after the collapse of three US lenders and the takeover of beleaguered lender Credit Suisse Group AG.
UK core prices — which exclude volatile food and energy costs — picked up again last month to 6.2% after decelerating to 5.8% in January. Services inflation jumped to 6.6% from 6%, a sign of increasing domestic wage pressures that is closely watched by the BOE.
“The BOE is dealing with inflation that is seeing no signs of abating, a labor market that is very tight and a strained global financial system,” said Pooja Kumra, senior European rates strategist at Toronto-Dominion Bank. “It’s a very tricky situation.”
UK headline inflation has remained at double-digit levels despite the fastest pace of rate hikes in three decades. The bank raised the benchmark rate to 4% in February, extending a tightening cycle that has lifted borrowing costs from 0.1% in late 2021. Money-market pricing implies around 60 basis points of further hikes, up from around 40 basis points at Tuesday’s close.
The BOE’s chief hawk Catherine Mann has warned that the UK risks facing the “worst of both worlds” in high inflation and low growth. On the dovish end of the nine-strong rate-setting committee, Silvana Tenreyro and Swati Dhingra have made the case for halting hikes, cautioning against overtightening.
Governor Andrew Bailey has stayed more neutral, saying that he has not decided whether more rate rises will be needed.
–With assistance from James Hirai.
(Updates with context throughout.)
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