Pound to Dollar Rate Volatile after Inflation Genie Seeps from Lantern in London

PoundSterlingLIVE – “Inflation in the UK continues to confound expectations” – Premier Miton Investors.

The Pound to Dollar exchange rate soon gave back short-lived gains in midweek trade after the Office for National Statistics (ONS) suggested an inflation genie may be seeping out of a lantern in London with a May consumer price outcome that is unlikely to have been welcomed by the Bank of England (BoE).

Sterling exchange rates rose almost across the board early in the European trading session on Wednesday but were quick to hand back gains following the opening bell in the London bond market after ONS inflation figures surprised notably on the upside of economist expectations.

Inflation was unchanged at 8.7% last month when surveys suggested an economist consensus was looking for a fall back to 8.4% but much more significantly, the core inflation rate climbed by a further 30 basis points to reach 7.1% in the latest reading.

“This is a disaster,” says Lewis Shaw, founder of Shaw Financial Services.

“This spells terrible news for the property market because the Bank of England will be under enormous pressure to hike rates tomorrow,” he adds.

The core inflation rate previously rose from 6.2% to 6.8% back in April and with a second consecutive increase now in tow the outlook for inflation is potentially in question.

The appears to suggest at first glance that the Bank of England may have been too optimistic when projecting in May that inflation would fall back to around 7% in July and to something like 4% by year-end but some economists say prices could still fall sharply in the months ahead.

“Core producer output prices rose at a three-month-on-three-month annualised rate of just 0.8% in May—the lowest since November 2020—pointing to considerable scope for core goods CPI inflation to decline from May’s 6.8% rate,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

“We continue to see little evidence of profiteering by retailers, so we expect food and core goods CPI inflation to fully reflect the decline in producer output price inflation over the coming months,” Tombs writes in reference to the producer price index figures released alongside the inflation data.

How quickly inflation does come down might well depend on whether companies make any further attempts to rebuild profit margins that were badly damaged during the invasion of Ukraine last year but there is a number of reasons why this risk could be high high.

These include wage pressures within the workforce where the relative price of skilled labour has been reduced by the near-10% increase in the national minimum wage back in April, as well as the double-digit number of increases in the Bank of England Bank Rate, which has lifted mortgage costs sharply since December 2021.

“My fear is that the wage-price spiral has also already arrived,” says Neil Wilson, chief market analyst at Markets.com.

“The stickiness of inflation left traders raising bets the Bank of England has to go into a more hawkish stance this week,” Wilson writes in response.

Recent inflation figures appear to stand the UK economy in contrast to its most comparable counterparts while the fears of a ‘wage-price-inflation spiral’ or otherwise a price-inflation-wage spiral are following on from more than a decade over which workforce income growth and core living costs have diverged.

Identifying the artist in this picture is a bit like a chicken or egg question but the data nonetheless leaves the BoE faced with a very difficult monetary policy decision on Thursday when many economists expect Bank Rate to be raised from 4.5% to 4.75%.

It’s far from clear, however, why after 12 earlier increases, one further 25 basis point increase in Bank Rate would be expected to put a dent in inflation if the overall measure is no longer falling and the core inflation rate has shown signs of resuming it earlier upward trajectory in both April and May.

“Inflation in the UK continues to confound expectations, having come in above expectations for 4 months in a row,” says Neill Birrell, chief investment officer at Premier Miton Investors

“Core inflation in particular is not falling as fast as hoped, which makes the Bank of England’s decision easier in some ways; a rate rise is certain, all they have to do now is decide how big it will be,” he adds on Wednesday.