A senior official at the Bank of England said that a sharp uptick in inflation showed that the central bank had underestimated the strength of the rebound in prices, and that monetary policy might have to be tightened earlier than previously thought.
Sir David Ramsden, deputy governor for banking and markets at the BoE, was speaking on Wednesday evening after figures showed Britain’s inflation rate rose to 2.5 per cent in June, far exceeding expectations and adding to pressure on the Bank of England to take the increase in prices more seriously.
“Based on the rapid pace of developments since we published our May forecasts and the shift in the balance of risks I can envisage those conditions for considering tightening being met somewhat sooner than I had previously expected,” Ramsden said.
The BoE does not give guidance on when it will start to tighten policy but, ahead of the June inflation figures, financial markets did not expect any rise in interest rates before 2023.
The Office for National Statistics said that the rise in prices was widespread in June, challenging the BoE’s view that any increase in inflation above its 2 per cent target would be “transitory”.
The third consecutive month of higher than expected inflation — which has climbed from an annual rate of only 0.4 per cent in February — indicates that businesses have responded to the relaxation of coronavirus restrictions with an effort to build profit margins.
The UK’s much faster rise in inflation than anticipated mirrors similar patterns in the US, where official figures showed this week that its consumer price index rose at an annual rate of 5.4 per cent in June.
Sterling edged higher on the news as traders brought forward their expectations of the first interest rate rise to late 2022 from mid-2023.
Economists had expected the rate of inflation to tick up from 2.1 per cent in May to 2.2 per cent.
Jonathan Athow, the ONS deputy national statistician, said: “The rise was widespread, for example coming from price increases for food and for second-hand cars where there are reports of increased demand.”
Measured by the consumer price index, UK inflation was at its highest level in June since August 2018.
With the BoE predicting that inflation would peak at about 3 per cent later in 2021, the rapid rise in prices in the second quarter suggests the peak will be considerably higher. Inflation is likely to surge sharply again in the autumn on the back of higher gas and electricity prices and higher restaurant prices when the temporarily reduced value added tax rate on hospitality is removed.
Paul Dales, chief UK economist at Capital Economics, challenged the BoE’s view that the rise in prices was simply a case of price cuts during the pandemic reversing. With more persistent and widespread price increases evident, he said, the figures showed “genuine price inflation is happening too”.
Inflation was likely to grow towards 4 per cent by the end of the year, Dales added, but also agreed that inflation was likely to moderate in 2022, allowing the BoE to hold tight with exceptionally loose monetary policy through an uncomfortable period.
Second-hand car prices were singled out by the ONS as a driver of inflation this year, as in the US, with buyers seeking used cars as an alternative to new, while car production had been severely hit by the global shortage of semiconductors.
The ONS said some of the price rises had temporary elements, such as the increase in costs at petrol pumps linked to higher oil prices and some prices rising after temporary cuts during the pandemic.
Although most economists share the view that the BoE will tough out the rise in inflation, James Sproule, chief economist of Handelsbanken in the UK, said the BoE’s Monetary Policy Committee should consider how persistently it had underestimated the rise of inflation this year.
“It is important to remember that as recently as February of this year, inflation was 0.4 per cent on an annual basis and there was talk of negative interest rates — all long gone and forgotten,” Sproule said, adding there was a need for the MPC to take the rise in inflation more seriously.
“At least a start to unwinding of the quantitative easing programme should be considered this autumn and that diversity of opinion on the MPC needs to be preserved,” he added.
In financial markets, traders responded to the inflation figures by betting the surge will force the BoE to raise interest rates sooner than previously thought.
Derivative markets linked to the path of BoE rates are now fully pricing in an increase to 0.25 per cent by November 2022. Prior to Wednesday’s inflation data, and the latest jump in US inflation this week, such a tightening in monetary policy had not been expected until May 2023.
Additional reporting by Tommy Stubbington