Traders are betting on an imminent end to the Bank of England’s string of interest-rate increases after inflation unexpectedly slowed to the lowest level in 18 months.
(Bloomberg) — Traders are betting on an imminent end to the Bank of England’s string of interest-rate increases after inflation unexpectedly slowed to the lowest level in 18 months.
The Consumer Prices Index rose 6.7% from a year ago in August, less than the 6.8% gain the month before, the Office for National Statistics said Wednesday. Economists had expected a rise to 7%.
Investors reacted by paring bets on further tightening aggressively, driving the pound to the weakest level since May and spurring a rally in government bonds.
The market is pricing a 50% chance of a quarter-point hike by the BOE when it sets policy next on Thursday. They are also betting that if it follows through with an increase, it will be its last. Goldman Sachs and Nomura went further, saying rates have already peaked.
“If there was any doubt the BOE was going to be cautious at its MPC meeting tomorrow, inflation figures just released in the UK totally back this approach,” said Roberto Cobo Garcia, head of G10 FX strategy at Banco Bilbao Vizcaya Argentaria.
The data is a relief for the UK, which for months has had the worst inflation problem in the Group of Seven. While the European Central Bank and US Federal Reserve have hinted their own tightening cycles could come to a close, the BOE so far has had to emphasize its determination to keep a lid on prices. It also may buoy hopes that Prime Minister Rishi Sunak will meet his goal of cutting inflation in half this year.
“The interest rate rises we have seen so far are doing their job and should be given more time to work before the Bank of England considers whether the base rate needs to rise further,” said Kitty Ussher, a former Treasury minister now working as chief economist at the Institute of Directors.
It’s quite the turnaround for markets. Earlier this week, an increase on Thursday was considered all but guaranteed and traders were penciling in even odds of one further increase beyond that by early next year.
What Bloomberg Economics Says …
“The big downside surprise in the UK’s August CPI release has raised the risk that the Bank of England doesn’t hike rates this week. On balance, we think the strength of pay growth will worry the central bank enough to deliver further tightening, but it could well come with a stronger signal that policymakers think this month’s move will be the last of the cycle. If that happens, and the drop in core inflation proves durable, it would all but quash the chances of a November rate rise, which is our current base case.”
—Dan Hanson and Ana Andrade, Bloomberg Economics. Click for the REACT.
The report is the biggest sign yet that the debate in the UK is shifting away from the danger of inflation and toward the dimming outlook for growth. While prices are still rising at more than three times the BOE’s 2% target, the report shows easing pressures in components of the survey that have been sticky.
A core measure of prices stripping out food and fuel fell sharply to 6.2% from 6.9%. Services inflation eased to 6.8% from 7.4%. Those will relieve concerns at the BOE that upward pressure on wages is making price pressures more persistent.
Pipeline price pressures continued to ease at the wholesale level, despite higher oil prices pushing producer input and output prices higher on the month. Compared with a year earlier, the cost of fuel and raw materials fell 2.3%, while the price of goods leaving factory gates declined 0.4%.
“We expect the Bank of England on Thursday to somewhat emulate the ECB and hike the Bank Rate one last time,” said Geoff Yu, forex and macro strategist for EMEA at BNY Mellon. “The move will likely be construed as a ‘dovish hike’ and this would be reinforced by the soft CPI print for August.”
This month’s report confounded expectations for a small uptick in prices due to an increase in fuel. While August’s lower-than-expected inflation reading will have cheered BOE policy makers, economists said it was too early be certain the hiking cycle is finished.
“With oil prices rising briskly in September, we can expect unhelpful monthly gains here that slow the deceleration in headline CPI,” said Melissa Davies, chief economist at Redburn Atlantic. “Taking a step back, inflation remains far too high in the UK but will continue easing into the end of the year.”
The BOE’s real challenge, she added, would be getting inflation down from 4% to the 2% target.
“The rate of inflation eased slightly this month driven by falls in the often-erratic cost of overnight accommodation and air fares, as well as food prices rising by less than the same time last year,” said ONS chief economist Grant Fitzner.
The swift surge in the BOE’s benchmark lending rate to 5.25% currently from near zero at the end of 2021 is starting to weigh more heavily on the economy. Official data and surveys show activity contracted in the first few weeks of the third quarter, reviving the risk of a recession.
The darkening mood is the latest headache for Sunak’s Conservative administration, which is trailing the Labour opposition in polls little more than a year before the most likely date for the next election. Sunak has made cutting inflation in half one of his five key priorities, but he’s also anxious to deliver growth to voters unsettled that their living standards are being squeezed.
“The plan to deal with inflation is working — plain and simple,” Chancellor of the Exchequer Jeremy Hunt said in a statement. “But it’s still too high, which is why it is all the more important to stick to our plan to halve it so we can ease the pressure on families and businesses. It is also the only path to sustainably higher growth.”
“Despite the latest fall, the Bank of England will still be concerned by signs of stubbornly high domestic price pressures,” said Alpesh Paleja, lead economist at the CBI, Britain’s biggest business lobby group. “As a result, another rise in interest rates tomorrow still looks more likely than not, though changes to monetary policy beyond this will be very data dependent.”
–With assistance from Eamon Akil Farhat, Irina Anghel, Alice Atkins and James Hirai.
(Adds Nomura’s view in fourth paragraph.)
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