M&G: UK inflation data suggest BoE should stay on course
Ben Lord, manager of the M&G UK Inflation Linked Corporate Fund, comments on the impact of UK monthly inflation data on the fixed income market.
CPI monthly inflation data rose to 2.9% in August from 2.6% last month, above expectations, and within a hair’s breadth of requiring a letter to the Chancellor. RPI data also rose to 3.9% from 3.6%, and again above expectations.
Increased fuel prices were expected this month, but August is also a high inflation month given transport price hikes that take place as people head away for holidays, and as clothing and footwear prices are hiked with the new season’s collections coming to shop shelves.
But it seems likely that we are close, now, to peak inflation in the UK. Given this, the Monetary Policy Committee (MPC) should look through any headlines this week and stay their course, given concerns around the outlook for the consumer, and enormous uncertainty about the post March 2019 economy. That being said, the risks of a 6-3 vote at the next monetary policy meeting have risen materially on the back of this number, as Andy Haldane has been pretty explicit on his discomfort with present levels of inflation, even if they are due to currency weakness and imports.
Increased disagreement on the MPC will likely lead to some sterling strength, in the short term at least, and it could see some downward reaction in short dated breakevens. But if we are a month or so away from peak inflation, to hike rates, strengthen the pound and reduce breakevens would be overly myopic and pro-cyclical in my view. It seems likely that inflation and breakevens are going to start to slide back from here gradually anyway: why accelerate and exaggerate those moves by acting a month or two early?
However, heightened disagreement and debate is necessary in the potential event that the Bank of England needs to raise rates more aggressively than the market is pricing in. Those expecting inflation to fall back from here are pricing the first hike to come in the middle of 2018 and the second hike to come at some point in the second half of 2019. If inflation doesn’t fall back for whatever reason – the most likely reason would be sterling weakness on account of Brexit debates – then the need to start bringing forward rate hikes and increasing their number intensifies. With 10 year gilt yields at 1% however, the bond market remains firmly nervous on the economy and unconcerned about the risk of hikes at this highly uncertain moment in time.