There’s going to be plenty of watchful eyes on the UK CPI report this Wednesday, not least with the autumn budget just around the corner. Another hot set of inflation numbers could very well make life rather uncomfortable for both the government and the BOE.
The headline annual inflation estimate is expected to rise to 3.4% in September, up from 3.1% in August. Meanwhile, core annual inflation is expected to also climb to 2.8% in September – up from 2.6% in the month before.
All in all, that would take inflation further away from the BOE’s 2% target, with higher energy costs continuing to put pressure on household budgets. At the same time, services inflation continues to be sticky and remains a problem for policymakers in trying to bring down broader price pressures in the UK economy.
And while the UK economy isn’t exactly falling apart, consumer demand remains fragile and the labour market has been showing signs of strain.
The August GDP estimate may have surprised with 0.1% growth, but that was largely driven by the production side as services output was flat on the month. Meanwhile, the latest labour market snapshot showed that payrolls continued to fall in August – marking a 0.5% drop in the past year alone. The unemployment rate for July was seen at 4.9%, also up by 0.2% from the past year.
So, that’s making for a bit of an awkward combination for the BOE. It isn’t all too worrying now but it could grow to be even more so if the diverging trends keep up.
For now, traders are already pricing in roughly 95% odds of a 25 bps rate hike for 5 November with another 25 bps increase priced by February next year. From that, the immediate move looks almost settled. The major worry right now I would say is whether the inflation trend will strengthen the case for further tightening.
But before we get to the BOE, there’s the 28 October budget to deal with first right after the inflation data this week.
UK chancellor Healey is vowing to provide relief to struggling households while keeping borrowing and gilt yields under control. So, higher inflation will just make that balancing act much harder. Additional fiscal support might cushion the energy shock, but an expensive package that unsettles bond investors could push borrowing costs higher anyway.
That is quite a lot of things all taking place in the span of the next two weeks.
A hotter-than-expected UK CPI report could reinforce expectations for further BOE tightening, even as higher interest rates squeeze households and businesses. On the flip side, a softer reading might offer some relief but it likely won’t be enough to make UK’s fiscal problems disappear.
Markets may be bracing themselves already for a November rate hike, but the real question that traders need to be concerned about is how much more tightening the UK economy can afford.
This article was written by Justin Low at investinglive.com.