Tuesday saw Sterling hit an 11-month peak against the Dollar, driven by August’s unexpectedly high UK inflation rate. With the Bank of England (BoE) policy meeting slated for today, FXTM’s Jameel Ahmad looks at what the outcome could mean for a fragile UK economy.
The Office of National Statistics announced that inflation in the UK topped 2.9% last month, putting it comfortably above the Bank of England’s 2% target. The markets immediately turned Bullish on the currency, and the Pound closed trading at US$1.3257 on Tuesday following the announcement.
Sterling weakness has been an ongoing theme since the UK’s shock Brexit vote. Concerns over the form Brexit will take, uncertainty surrounding trade deals and the outcome of the general election have weighed heavily on the currency in recent months. This has been felt throughout the economy, and the 0.3% rise in The Consumer Price Index from July to August has been driven not by dollar priced commodities or domestic services, but by clothing and footwear, which posted a record inflation of 4.6%.
BoE Governor, Mark Carney, is on record suggesting that higher inflation rates may prompt an interest rate hike, and the markets will be waiting to see if the hawks are out in force at today’s policy meeting. Wage growth has failed to keep pace with inflation, and elevated inflation rates are squeezing British households. The BoE is under pressure to address the issue, but an interest rate hike could impact business confidence, and risks damaging an already fragile economy. It’s a tough choice; rein in inflation and potentially impact both jobs and growth, or relax policy, encourage growth and employment and deal with rampant inflation further down the line. To date, BoE decisions have appeared to favour the second option.
The question now is whether the BoE will commit to a rate hike before the European Central Bank. Some argue that the Euro’s recent strength may compel the BoE to normalise monetary policy sooner rather than later. That said, Brexit induced sterling weakness has been ongoing for nearly 14 months, we are approaching the point at which year-on-year inflation calculations will move beyond the ‘Brexit effect’, and it is likely inflation will fall back when that happens. Could the BoE be counting on this to justify keeping interest rates low?
August’s MPC meeting saw two votes for interest rate hikes, with the remaining six votes cast to leave rates unchanged. It seems unlikely that the committee will swing towards a hike today, but one cannot be too far away. UK inflation has tracked above the BoE’s 2% target for much of the year, and Tuesday’s unexpected peak near the 3% mark will have many on edge. The fact that the rise is driven by increases in consumer goods is indicative of ongoing Sterling weakness, and will put further pressure on BoE decision makers to support consumers.
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