Inflation moves higher in the UK

UK CPI came in slightly higher than expected for June, accelerating to 9.4% y/y from 9.1% the previous month and beating market expectations of 9.3%. On a monthly basis CPI inflation rose by 0.8%, up from 0.7% a month earlier. Core CPI, removing food and energy prices came in at 5.8%, just below the previous figure of 5.9% and inline with market consensus. Housing, household and transport costs remain the primary drivers of gains in inflation overall, with transport up by 2.4% last month whilst food & beverages and the hospitality sector were both up by 1.2%. 

The elevated inflation picture in the UK affirms our view that the Bank of England will hike rates by 50bps at their MPC meeting in early August, taking the Bank Rate to 1.75%. We expect a steady path of hikes over the rest of this year, with another 50bps at the September meeting before 25bps in November, bringing policy rates to 2.5% at the end of 2022. The impetus for a 50bps hike in early August received a further boost overnight from Governor Andrew Bailey who indicated it would be an option during a speech in the City of London earlier this week.

The difficult inflation picture in the UK comes amid a change in political leadership as the Conservative Party in the UK is in the process of selecting a new leader. Rishi Sunak, a former chancellor of the exchequer, has committed to higher taxes to repair the government’s balance sheet while several of his fellow contenders have opted for a looser fiscal stance. We expect it would be hard for most of the candidates to avoid the temptation of a fiscal boost to support the economy in a recession or considerable slowdown, which could end up extending the period of high inflation. At the same time, major public sector unions have threatened strike action in protest at wage increases that are below the inflation rate, adding to the risk of a wage/price spiral.

Even as the Bank of England is likely to commit to a further series of rate hikes, policy rates will still be well below those of the Federal Reserve, on our expectations, and a weak economy amid political uncertainty will continue to weigh on sterling. We maintain our forecast for GBPUSD in Q3 at 1.20 on the top end with the risk of considerable time spent well below that level.