March’s CPI inflation data out of the UK will be a harrowing message to the Bank of England and one that will likely keep the central bank firmly in tightening mode despite manifesting growth concerns.
This morning’s data saw headline CPI rise from 6.2% to 7% in March, exceeding expectations by 0.3%, while the core measure also beat expectations but by 0.4% with a print of 5.7%, up from 5.2% in February. The headline measure marks the highest 12-month rate since the year-on-year series began in January 1997 and the highest rate of inflation since March 1992 in the historic modelled series. More worryingly for monetary policy setters, inflation is set to rise further in April given the Ofgem energy price cap is set to be upwardly adjusted by 54%, which should add 1.4 percentage points to the headline rate.
Within the CPI basket, transport and restaurants and hotels provided the biggest contribution to the 0.8% increase in the year-on-year rate at 0.26% and 0.22% respectively. This likely reflects both the settled domestic Covid conditions and the initial passthrough of higher energy and food prices. Fuel prices in March rose 9.9% month-on-month, the highest on record, while food and drink inflation rose from 5.1% to 5.9% year-on-year in March, the highest rate since September 2011.
The surge in agricultural prices driven by the war in Ukraine suggests that the recent surge in food price inflation is likely to persist in the coming months.
Meanwhile, consumer discretionary goods such as clothing and footwear and recreation and culture provided a limited contribution at just 0.04% and 0.03%. This is a marked reduction after contributions of 0.17% and 0.25% in February. The shifting drivers of the rise in headline inflation on a monthly basis highlights the broadening of price pressures, and hence the need for sustained action by the BoE. As does the fact that out of the 52 sub-measures and components of inflation, 42 are currently tracking above 4% on a year-on-year basis – a rate that is twice that of the BoE’s inflation target.
The data today confirms that the Bank of England will need to keep their foot on the monetary policy brake in May, resulting in another 25bp rate increase in our view.
With Bank Rate resting at 1% after a 25bp hike, the question for the Monetary Policy Committee will then be how aggressively they will want to draw down on their balance sheet as the 1% threshold marks the point where active Gilt sales will be discussed. This may be a more favourable avenue to tighten policy for the more dovish BoE members, such as John Cunliffe who previously voted to hold rates at 0.75%, as quantitative tightening is estimated to have a smaller impact on tightening financial conditions that interest rate hikes. While for now, with inflation set to spike close to 9% in the coming months, we expect the BoE to remain proactive in hiking interest rates to mitigate how high medium-term inflation expectations rise, however, we don’t think the tightening in H2 will be as plain sailing as it was on the way up to 1%.
Drivers of the year-on-year inflation increase change hands, highlighting the breadth of the inflation surge
Simon Harvey, Head of FX Analysis