Inflation is rising faster than expected but the latest data is unlikely to shift the Bank of England’s stance on interest rates.
The headline rate of inflation hit 3% in January, up from 2.5% the previous month and higher than the 2.8% forecast by economists and the Bank of England.
It’s expected to go even higher, hitting 3.7% later in the year and moving even further away from the Bank’s 2% target.
Policymakers are hopeful that we are in a “hump” and that inflation will fall back to target.
The latest increase was driven by a bigger-than-expected surge in airfares because of an erratic comparison with the same period last year and a VAT rise on private school fees.
The Bank won’t be too concerned about that.
It will also look through increases in food prices, which can be volatile.
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Core CPI inflation, which strips out the volatility by excluding food as well as energy, rose from 3.2% to 3.7%. That was in line with forecasts.
Services inflation, which gives a better indication of underlying price pressures in the domestic economy, rose from 4.4% to 5%. That was lower than the Bank of England’s 5.2% forecast.
It means the Bank is likely to continue its measured approach to monetary policy.
Although inflation is above target, weak economic growth has been weighing heavily on the minds of the Monetary Policy Committee (MPC).
It’s a balancing act. Two MPC members voted for a large 50 basis point interest rate cut this month. While the Bank is unlikely to cut again next month it is still expected to push through another two interest rate cuts this year.
The Bank will have to hold its nerve.
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Wages are growing at their fastest pace in three years and rising energy prices will drive inflation higher this year, but the Bank expects the headline rate to then start falling.
Weak economic growth should weigh on wages, taking the heat out of price pressures.
That is the Bank’s reading of the situation, but the last few years have shown us that the “inflation tiger” can be an unpredictable beast and the geo-political risks continue to abound, particularly the US president’s tariffs policy.
Rob Wood, chief UK economist at Pantheon Macroeconomics, said: “The risks are pointed towards higher than expected inflation this year.
“We think the MPC would be ‘brave’ to keep cutting rates quarterly with wage growth around 6% year-over-year – at least double the rate consistent with inflation at target – stalling rather than collapsing jobs, and inflation well above 3%.
“We look for two more rate cuts this year, in May and November.”
