UK Inflation Surge Adds Pressure on BOE

The Bank of England's (BOE) Monetary Policy Committee (MPC) is set to meet tomorrow, Thursday, March 23, and is expected to raise interest rates by a quarter percentile to 4.25%. Analysts are speculating that the central bank might ignore the chaos around UBS’ purchase of Credit Suisse and prioritise fighting rising inflation.  

In fact, the bank is expected to use targeted measures to address risks to financial stability, similar to those implemented in September of 2022 during the "mini-budget" crisis. This will allow the MPC (Monetary Policy Committee) to use more traditional measures like interest rates to target inflation. With the ONS (Office for National Statistics) reporting a surprise jump in inflation earlier today, pressure on the BOE to raise rates at its meeting tomorrow has intensified.

UK Food Prices Spike to 45-year High

UK CPI change rose to 10.4%, shocking the markets as it was well above the 9.9% expected and even up from the prior month's 10.1% print. Monthly inflation was recorded at 1.1%, surpassing expectations of an increase of just 0.6%. The data marked a break from the three consecutive months of slowing inflation growth after hitting a 41-year high back in October.

The ONS pointed to the most significant contributors to the increase in February’s CPI being food, clothing and food services. Food and non-alcoholic beverage prices increased at an annual rate of 18.2%, the highest level seen in 45 years, but it was offset somewhat by a drop in motor fuel costs. The ONS also said that the "salad crisis", which has resulted in a lack of tomatoes, peppers, and cucumbers, was the driving force behind the rising cost of fresh food. (Source:CNBC)

Changing Expectations?

As of yesterday, Tuesday, March 21, analysts were convinced that it was a close call for whether the BOE would hike rates, with markets pricing in just a 56% chance of a 25 basis-point rate hike, while the remainder expected no change. Until Tuesday, data had been coming in mixed, with better-than-expected performance in the economy and a strong labour market. On the other hand, analysts pointed to the need to address fragile conditions in financial markets, leading to suggest the possibility of just one more 25 bps hike, which could support the British pound (GBPUSD).

The latest inflation data gave a boost to cable as traders saw this as an indication that the BOE would hike rates. Following the CPI release, traders are in full compliance with a quarter rate hike from the BOE on Thursday, March 23. But the BOE closely tracks core CPI, which excludes the impact of food and energy, and not headline inflation. However, the core measure also rose well above expectations to 6.2% compared to the 5.7% forecasted and the 5.8% reported in the prior month.

The Backdrop Against Hikes

The unease around the stability of the global banking system has recently rattled markets. As a result, several central banks are expected to address the handling of the economy in a series of appearances following rate decisions this week, including members of the BOE. 

In fact, earlier in the week, it was announced that the BOE joined the Fed, ECB, SNB, BOC and BOJ in taking coordinated action to increase liquidity in international markets and support banks by increasing the dollar swap lines. The measure was seen bringing some calm to the markets, reducing the strain on the supply of credit.

Meanwhile, some analysts pointed out that central banks could cause investors to worry if they leave rates unchanged because it would suggest they were aware of underlying risks to the financial system that market participants don't know about. 

As if the BOE does not have enough to deal with ahead of the next MPC meeting tomorrow, the DUP (Democratic Unionist Party) announced it would vote against the Windsor framework of the Brexit deal, sending the pound 0.6% lower on Tuesday. DUP leader Jeffrey Donaldson said in a statement that the deal doesn't resolve fundamental problems, and there were key areas of concern. The decision is seen as emboldening the European Research Group of MPs to vote against the government's proposal. However, support from Labour might guarantee that the motion that overhauls the Northern Ireland Protocol will pass.

Conclusion

Markets raised expectations that the BOE would raise rates by 25bps when it meets tomorrow, Thursday. The pound rose in response, as the latest UK inflation data showed price increases had accelerated well above expectations and the prior month's reading, at 10.4%. However, traders will have to keep a keen eye on tomorrow’s upcoming rate decision to see how the latest banking escalation may have affected BOE’s decision, if at all.