The UK inflation report for August today is going to be the main highlight in terms of economic data releases in the European session later today. With it coming just a day before the BOE rate decision tomorrow, it is the last meaningful piece of the puzzle for policymakers before they cast their votes.
To start off, let’s see what the numbers have to say.
Headline annual inflation is expected to rise to around 3.1% in August, up from 2.9% previously. That is roughly three tenths above the BOE’s own forecast.
Just on that alone, it sounds rather uncomfortable. However, I wouldn’t get too carried away with the headline figure on its own as the devil is always in the details when it comes to inflation data.
Much of the jump in headline inflation is expected to come from the surge in petrol and diesel prices, which could account for roughly two tenths of the forecast miss. That matters because policymakers will be much more interested in whether the latest energy shock is spreading to other key categories rather than simply reacting to higher fuel costs themselves.
That once again puts the spotlight on core annual inflation. That is expected around 2.6% in August, keeping unchanged from the reading previously.
Core goods inflation is expected to be broadly stable, so that will put services inflation firmly in focus.
The consensus for the latter is for around 3.5% and that is still well above the BOE’s forecast of around 3.26%. That being said, categories like air fares could make the reading particularly noisy. July’s air fare increase was unusually soft, so some normalisation in August is expected. Analyst estimates vary enormously, but a rise of around 10% m/m would alone contribute roughly 8 bps to services inflation. So, that is something to take note of.
But in other words, a 3.5% services print isn’t necessarily as hawkish as it might first appear to be. The details matter.
And that will probably be the key distinction for the BOE decision tomorrow. The central bank already knows that inflation is going higher. But what policymakers really need to know, is whether those price pressures are becoming more embedded elsewhere in the economy.
So far, the evidence for meaningful second-round effects remains limited.
With that in mind, an in-line report should still allow the BOE to get away with keeping the bank rate unchanged at 3.75% tomorrow.
A meaningful upside surprise in underlying services inflation (in turn, core annual inflation) could still see markets bring forward expectations for another BOE rate hike. For sterling and gilts, that will be the key spot to watch when it comes to the release later. However, it will take a very sizable surprise to convince of a change for markets to price in a rate hike for this week.
The current backdrop shows that traders have already fully priced in a 25 bps rate hike for November next with another in December almost fully priced in as well. The market pricing trajectory through to June next year sees ~103 bps of rate hikes priced in. So, how the curve moves here after today’s report will be the more interesting bit.
This article was written by Justin Low at investinglive.com.