News & analysis

The latest UK inflation figures show that price growth eased at a slower pace than expected in April, with all notable measures beating market expectations.

Granted, headline price growth fell from 3.2% YoY to 2.3%, only just above the Bank of England’s 2% target and falling below levels seen in France or Germany, an outcome that we suspect is likely to dominate many newspaper front pages. But that largely reflects strong base effects and masks the underlying inflation picture. Not only did today’s print overshoot consensus projections but it also landed above the Bank’s forecast back in May, both of which had predicted that the measure would ease to just 2.1%. More notably for markets, however, is the services inflation measure. Seemingly central to the BoE’s discussion on rates at present, this measure barely budged, falling from 6.0% in March to 5.9% YoY. When set against Bank staff projections that expected a reading of 5.5% this month, this is a significant overshoot.

As such, we think this should tip the MPC towards holding rates in June before starting to ease policy from August onwards. This is being reflected in market pricing this morning, leaving sterling to trade marginally higher against its peers.

Like many sell side desks, we had singled out today’s report as key for the BoE and the prospects of a June rate cut. Given the tone of the May Monetary Policy Report, we felt that the Monetary Policy Committee would only need to see inflation readings in line with or below their forecasts to cut rates in June. That said, we also warned that risks to today’s release were tilted to the upside, given some services components exhibit price resetting at the start of the fiscal year and the potential impact of a rise in the National Living Wage (NLW). With this in mind, we think the details of this morning’s release are likely to make for some grim reading on Threadneedle street. A large fall in headline CPI had been widely expected, the result of favourable base effects and a further reduction in energy costs. Similarly, once stripping out volatile food and energy costs, core CPI was also expected to ease modestly, and did, down to 3.9% YoY from last month’s 4.2%. But, notably, this still overshot staff expectations for a 3.6% print, with this unexpected strength almost entirely attributable to greater than expected price rises across services components.

Indeed, it is this services inflation that is likely to trouble the MPC. Here, much of the strength appears to be concentrated in wage sensitive components.

As an example, while price growth for recreation and culture as a whole eased by 0.9pp in April on an annual basis, recreation and cultural services inflation jumped, with prices rising from 5.1% to 7.1% YoY. The similarly wage-sensitive accommodation services also saw a notable increase in prices, from 6.0% YoY in March to 7.1% in April, while catering services, which includes restaurants and cafes, eased just 0.1pp to 5.7%. Admittedly, this strength could be due to Easter effects, making it a one off. But we think a more likely explanation is wage passthrough from the April 1st rise in the NLW, though this would conflict with an alternative signal from recent PMI reports, which suggested that any passthrough would be limited.

Either way, this uncertainty is now likely to trigger a degree of caution within the MPC, weighing strongly in favour of delaying any decision to cut the Bank Rate, at least until August when more clarity on the impact of the NLW rise is available.

Markets appear to share this view too. Following this morning’s release, expectations of a June rate cut have dropped from close to a coin flip, down to just 14%, as markets now align with our longstanding call for an August start to UK policy easing. From an FX perspective, this widening of expected rate differentials in sterling’s favour has seen the pound rally too, with both GBPUSD and GBPEUR rising by 0.3% so far this morning.



Nick Rees, FX Market Analyst


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